This week saw positive data on US consumer spending. However, US employment improved less than expected. US manufacturing activity appeared a little weaker, but still grew. In the Eurozone, low inflation prompted the prospect of further monetary stimulus for the region. We also saw the end of the third quarter of the year, which marked the worst quarter for global financial markets since 2011, as concerns over Chinese growth and global commodity pricing weighed on markets. While many investors have not been pleased with the direction markets have headed in recent months, you should always keep in mind that such pullbacks and volatility are actually quite a common component of financial markets and a normal part of investing. Furthermore, recent weeks have seen lower volatility.
This week we want to discuss the bonds (aka fixed income) that you may have in your portfolio. Fixed income, just like equities, is a diverse asset class. Factors such as how long until a bond is expected to be repaid, and the credit quality of the entity issuing the bond can cause different bonds to respond in diverse ways to market events. For example, a short-term government bond can be a very stable investment in most scenarios. On the other hand, high yield bonds can, at times, appear to trade more like a stock than a traditional bond. It is also worth noting that, contrary to popular belief, bonds have generally offered positive returns during periods of tightening monetary policy according to the recent book Invest With The Fed: Maximizing Portfolio Performance by Following Federal Reserve Policy, by Robert R. Johnson.
At FutureAdvisor we typically implement or recommend portfolios that include fixed income investments that are generally high credit quality, internationally diversified, and of moderate duration. These properties mean that the fixed income element of our portfolio helps to offer stability during times of equity market weakness, which is one of the many reasons why we believe bonds can help smooth portfolio returns over time. As you would expect, we generally use fixed income ETFs that can contain thousands of different bonds. We also diversify fixed income instruments by including foreign bonds. At a time when the US may be close to raising rates, many countries internationally are moving in the other direction. Finally, we also include or recommend Treasury Inflation Protected Securities (TIPS) as part of fixed income exposure, like the real estate component of your portfolio, we expect to help offer stability - especially when inflation rises.