Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



The Bond Market Massacre Began on This Day

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Stocks recorded their worst day of the year, as the S&P 500 (INDEX: ^GSPC) and the narrower, price-weighted Dow (INDEX: ^DJI) were down 1.2% and 0.9%, respectively. Predictably, the VIX Index (INDEX: ^VIX) shot up 14%, to close at 14.67 (the VIX, Wall Street's "fear gauge," is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days).

Another lesson from the mid-'90s
Last Friday, this column walked down memory lane to 1996 to illustrate why higher unemployment is good for stock prices. Today, our destination is 1994, for a lesson on the risks of owning bonds in a zero interest rate environment (i.e., when policy rates can only go up). Indeed, 19 years ago today, on Feb. 4, 1994, the Federal Reserve unexpectedly raised the federal funds rate by 25 basis points -- the first increase in five years (Note: One basis point is equal to 100th of a percentage point.) That month, long-term Treasury bonds -- those with the greatest sensitivity to rising rates -- lost 4.5%.

Before the year was out, the Fed had raised rates six more times, for a total increase of 2.5 percentage points. Fortune called it a "bond market massacre," estimating U.S. bond market losses through the third quarter at $600 billion (that was real money back then). Investors weren't even able to rely on their stock holdings to make up for these losses -- the total real return on the S&P 500 in 1994 was negative 1.1%.

Losses are not atypical under such circumstances: Fund manager Vanguard has calculated that, between 1973 and 2010, the average 12-month real return on a 60% stocks/ 40% bonds portfolio during periods in which interest rates increased by at least 200 basis points is negative.

Last Friday's surprise pushed forward into the future any interest rate hike by the Fed. That prospect is not imminent. However, as the events of 1994 prove, the Fed can surprise; furthermore, it only has partial control over long rates. Once rates start to go up, most investors won't be able to reposition themselves fast enough. Investors need to be nimble beforehand.

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in our brand-new free report: The Motley Fool's Top Stock for 2013. I invite you to take a copy, free for a limited time. Just click here to access the report and find out the name of this under-the-radar company.

Read/Post Comments (0) | Recommend This Article (6)

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2235050, ~/Articles/ArticleHandler.aspx, 9/27/2016 5:17:13 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated 8 hours ago Sponsored by:
DOW 18,094.83 -166.62 -0.91%
S&P 500 2,146.10 -18.59 -0.86%
NASD 5,257.49 -48.26 -0.91%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/26/2016 4:35 PM
^DJI $18094.83 Down -166.62 -0.91%
^GSPC $2146.10 Down -18.59 -0.86%
S&P 500 INDEX CAPS Rating: No stars
^VIX $14.50 Up +2.21 +17.98%
Volatility S&P 500 CAPS Rating: No stars