Emily Keenan

Most investors would probably like to forget the poor performance of both bonds and equities in 2022 and early 2023.  For many investors it was their first real experience of bonds falling in value, particularly at the same time as equities.  Different investors would have experienced different outcomes in 2022 (and subsequently) depending on the type of bonds that they held. It is worth revisiting what has happened since then.

Going back to first principles, we can remind ourselves of several characteristics that apply to bonds: bond prices move in the opposite direction to bond yields i.e. when bond yields rise, bond prices fall; the prices of bonds with maturities further into the future are more sensitive to changes in yields than shorter-maturity bonds, making their prices more volatile; the lower the quality of the borrower issuing the bonds, the more like equities they behave; and finally, bond markets do not like inflation, generally driving up yields in the face of rising inflation.

In 2022, with the growing threat of high inflation following Russia’s invasion of Ukraine, exacerbated by the instability of the unfunded tax promises of the Conservative government under Liz Truss, bond yields rose dramatically and substantially.  The bond see-saw moved violently, with those owning longer-dated bonds suffering material and painful falls in value.  Those who owned shorter-dated bonds fared better, but even so delivered falls in value. Yet, bond owners from that point on began to benefit from the higher yields that their bonds now delivered, recouping some of those falls in value.  Take a look at the chart below which shows how far bonds fell for different maturities and what the return has been in cumulative terms since the start of the fall. As one can see, a big bond bounce-back for shorter-dated bonds has occurred, back to where they started, while longer-dated bonds still sit deeply underwater.

Figure 1: Bond falls and recoveries vary depending on what you own.

Source: Morningstar Direct © All rights reserved – see endnote for details. 

It is evident that shorter-dated bonds have recovered far more quickly than longer-dated bonds as the prices of the former fell less far, and the consequent higher yields have helped to recoup these falls, at least in nominal, pre-inflation terms.  At their worst, shorter-dated global bonds were down around -7% in 2022. However, they delivered just over +5% in 2023, and around +1% to the end of June this year following small yield rises across major markets.

We have always tended to favour shorter-dated bonds for this reason believing that the small premium available in lending for longer is outweighed by the downside protection that comes from owning shorter-dated bonds alongside their bounce-back-ability!

Risk Warnings:

This article is distributed for educational purposes only and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Use of Morningstar Direct © data

© Morningstar 2024. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.

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It feels like 2024 is the year of the election with over 64 happening in various countries around the world covering around 50% of the world’s population[1]!  These range from the farcical pretense of the re-election of Putin, to that in the UK.  At this time, it looks like a probable victory for the Labour party over the incumbent Conservatives, seemingly with a large majority.  In the previous election in 2019, British politics was polarised between Boris Johnson’s ‘getting Brexit done’ mantra and a very left-wing alternative of Jeremy Corbyn and his ‘magic money tree’. Today, the two main parties are vying for far more central ground that tends to win elections. Who said democracy does not work?

In India, the world’s largest democracy, the people have spoken and have put a dent in the BJP and Modi’s ambitions of an overwhelming 400 seats.  They gained just 240 instead, without a majority.  The EU Parliament elections are due to begin, with concerns over the growing impact of the far-right.  Throw in the US election chaos in November and investors might wonder how to process all of this in terms of what might happen to their portfolio.

Well, the good news is that the markets have done this already for you!  It is no doubt, for example, pricing in the probability of a Labour government and what it thinks about its policies, as far as they are known. That is what markets do.  They incorporate all public information into prices quickly and efficiently, meaning that prices only move on the release of new information, which is random.  The stock market tends to be pretty resilient for those with the patience to sit out any passing market storms.  It seems to be obligatory at these times to roll out a chart with the colours of the different parties indicating the periods they are in power – say in red for Labour and blue for Conservative – and showing the growth of the market.  It does not tell you much, apart from these events have little impact, as the market prices in events well before they happen.  So here it is.

Figure 1: The UK market’s growth of wealth over time, irrespective of who is in power.

Source: Albion Strategic Consulting. Data: CT FTSE All-Share Tracker 1 Inc (GB0008464199) from 01/10/1988, Vanguard FTSE UK All Shr Idx Unit Tr£Acc (GB00B3X7QG63) from 01/01/2010. Not a recommendation. Data in GBP in nominal terms. Election results data from House of Commons Library.

It really is pointless to try to predict an outcome any different to that already reflected in today’s market prices.  What is your thesis? How have you interpreted the information that you have to hand? How is your view different to everyone else who is thinking similar thoughts?  The reality is that is really hard to outguess the market view reflected in prices.

As you see from the figure above, these periods of political power are plotted against the UK market. But what does that tell you? Over 80% of the earnings of the UK market come from overseas, so how meaningful is it to just look at UK politics. Not only that, but the UK is likely to represent only a fraction of your global portfolio, as it only represents around 4% of total world market capitalisation.  So, you will need to factor in all 64 elections, all other world events known and as yet unknown and decide how to position your portfolio accordingly.

Alternatively, you could be patient, trust that the markets work pretty well and reflects the aggregate view of all investors and believe in the power of capitalism to deliver rewards due to you as the part owner of companies (equities) and as a lender (bonds).  We advise the latter approach.

The most important thing you can do is to vote.

Risk Warnings:

This article is distributed for educational purposes only and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

[1] TIME (2023) The Ultimate Election Year: All the Elections Around the World in 2024. https://time.com/

Over the longer term, investors expect a positive, after inflation return from investing in company shares and lending money to governments and companies by owning bonds.  Unfortunately – and inescapably – in the shorter-term market returns are anything but predictable. They contain a lot of noise, as the market absorbs new information into prices.  High inflation in 2022 led to a rapid rise in interest rates around the world, contributing, in part, to the fall in global bond and equity prices. It was a painful backward step and a reminder that the road to long-term returns can be bumpy and painful at times. With these now higher yields, some investors may have been tempted to hold more cash but roll forward a year and that would have been a poor decision in the short term.  It is nearly always a bad decision in the long term for those with long investment horizons.  Fortunately, 2023 has delivered a much more positive story.

Looking Backwards

Last year all core assets delivered positive returns. The US market – and in particular the ‘Magnificent Seven’ as the press have dubbed the big tech firms – regained the losses they suffered in 2022.  In fact, they contributed around three quarters of the return of the US market over the year.  As a consequence, global developed market returns were very strong, given that the US weight in global markets is around 63%. Value companies underperformed in the US (largely because of the overwhelming impact of the ‘Magnificent Seven’) but made a strong contribution outside the US.  Both value and smaller companies outperformed strongly in emerging markets. Global commercial property (REITs) also managed a positive return.

On the defensive side of portfolios, high quality, short-dated bonds have recouped over half of the falls suffered in 2022 – largely on account of the higher bond yields, which caused the pain in 2022 – delivering returns similar to cash.

Figure 1: Global investment returns – 2022 and 2023 compared

Data: Funds used to represent asset classes, in GBP. See endnote for details.

Sensible, systematic portfolios comprising a diversified ‘growth’ basket of equities – with tilts to value and smaller companies – paired with ‘defensive’ short dated high-quality bonds will have delivered robust returns in 2023, somewhere in the region of 9% for a 60/40 split respectively in GBP terms[1]. Investors with portfolios denominated in GBP suffered a small currency drag over the year as Sterling appreciated against the US Dollar by around 4%, as well as most other major currencies.  Year-on-year inflation in the UK fell to 3.9% in November, down from 10.5% at the start of the year.

Looking at three-year cumulative returns helps to illustrate the benefit of remaining invested through tough years such as 2022. Bond returns have been poor due to starting yields around 0% at the start of the period followed by subsequent yield rises (and thus bond price falls), but these were more than compensated for by strong growth asset returns.

[1] Refer to table in the endnote for underlying funds and allocations.  This is provided for informational insight only and does not represent any form of advice or recommendation.

Figure 2: Cumulative global investment returns – three years to the end of 2023.

Data: Funds used to represent asset classes, in GBP. See endnote for details.

Looking Forwards

The outlook for the global economy looks a little bleak as major economies teeter on the brink of recession, including the UK.  China has deep and wide economic problems that are restraining its growth prospects.  Inflation has come down in the EU (2.4%), US (3.1%) and UK (3.9%) from recent double digit highs.  Risks remain – including conflict in the Middle East impacting energy and supply chains –and the final yards to reach central bank target levels of inflation (2% in the UK) will be harder to achieve and vulnerable to geopolitical risks.  Interest rates may well remain elevated relative to the low rates that investors experienced up until early 2022, which is good for bond holders.

It is useful to remember that forward-looking views are already reflected in today’s prices.  What comes next, no-one truly knows. The key is to remain highly diversified, resolute in the face of any market set-backs and focused on long-term goals.

And finally…

More broadly, Putin continues to wage his illegal and brutal war in Ukraine and the terrible humanitarian tragedy unfolding in Gaza seems to have no resolution in sight. Our thoughts are with all the innocent people caught up in these conflicts.

This year we face the prospect of elections in democracies such as the UK, US, Taiwan, India, Pakistan, Indonesia, and within the European Union.  US politics is as deeply partisan as it has ever been, raising the level of uncertainty about the future.  The democratic process is always combative, often messy and sometimes ugly.  Let us hope that these elections result in governments that fulfil Lincoln’s wish set out in his Gettysburg Address after the Battle of Gettysburg in 1863:

‘that these dead shall not have died in vain—that this nation, under God, shall have a new birth of freedom—and that government of the people, by the people, for the people, shall not perish from the earth.’  

In the UK, it is certainly possible that the Conservatives will struggle to remain in government.  As Churchill once said:

‘Many forms of Government have been tried and will be tried in this world of sin and woe. No one pretends that democracy is perfect or all-wise. Indeed it has been said that democracy is the worst form of Government except for all those other forms that have been tried from time to time.…’

Winston S Churchill, 11 November 1947 

On a brighter note, it is worth remembering that despite the conflicts in the world, seeming discourse in democratic nations and the rise of autocratic and despotic leaders, the world we live in is better in many respects than ever before.  While 659 million of the world’s population live in poverty, this is down from 1.9 billion in 1990 and 902 million in 2012[1].  Global under-5 mortality has dropped by 60%, 2.1 billion people have gained access to safe drinking water since 2000 and today 40% of board seats in FTSE 350 companies are held by women (10 years ago 150 or so of these companies had no women on their boards)[2].  These lesser known facts are a strongly positive counterbalance to the immediate troubles that the world faces.

From an investing perspective, we remain hopeful for the best in 2024 but remain prepared for the worst, as is always prudent.

Happy New Year!

[1] https://borgenproject.org/victories-fighting-poverty/

[2] Sunday Times magazine, December 31, 2023. ‘Really, actually, properly excellent things that happened in 2023’

Risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Data series used:

More information is available on request.