Please ensure Javascript is enabled for purposes of website accessibility

This Surprise Winner Is Climbing on Coronavirus Fears

By Dan Caplinger – Feb 28, 2020 at 10:02AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

For years, experts have been wrong in expecting this investment to post big losses.

When 2020 began, investors were coming off a strong year for the stock market and hoped that the good times would continue. Markets obliged those optimistic views for a while -- until coronavirus fears sparked the fastest correction in stock market history, sending Dow Jones Industrials (^DJI) down thousands of points in a single week.

Yet even as stocks lost all their gains for the year and continued lower, another asset class kept up its surprising run of outperformance. Year after year, the bond market has managed to dodge bullets and produce solid returns for investors. Despite bond yields already being at rock-bottom levels, investors' worries about the Covid-19 outbreak managed to push those yields still lower, producing double-digit percentage gains for bond investors to offset their stock market losses.

Old style bond security highlighting the word Bond.

Image source: Getty Images.

What goes down keeps going down

Bond market watchers have been nervous about the long-term prospects for bonds for a long time. Rates on long-term 30-year bonds stayed below 4% throughout most of the 2010s, and every time it's looked as though the economy might start to heat up, bond investors have grown concerned that even modest increases in long-term rates could cause a big drop in bond prices. That's what happened in the second half of 2016, when the iShares 20+ Year Treasury ETF (TLT -0.56%) lost nearly 20% over the span of just a few months when long-term rates jumped from around 2.25% to above 3%.

More recently, though, interest rates have defied predictions. In late 2018, it appeared that the Federal Reserve might continue to raise short-term interest rates, which had pushed yields to their highest levels in years. Yet the Fed abruptly did an about-face and cut rates when it appeared that economic sluggishness might stall out the recovery. Now, with the coronavirus raising all kinds of uncertainty about the future of the global economy, investors have sought whatever safe havens they can find. Long-term Treasury bonds have been the answer, sending rates to historic lows and bond prices soaring.

TLT Chart

TLT data by YCharts.

Long-term bonds are especially sensitive to rate movements, which explains how they can produce gains of 13% even when they're yielding less than 1.75%. Because the existing holdings of the long-term Treasury ETF have fixed rates, their prices go up when prevailing rates go down, because the relatively higher interest payments they make look more attractive in a lower-rate environment.

The danger of bonds

Bonds have traditionally played a key role in balancing investors' portfolios. It's not uncommon for stocks and bonds to move in opposite directions, as they've done lately, helping to offset each other's moves and produce smoother gains over the long run. That's why you'll typically find bonds prominently included in asset allocation strategies.

The challenge going forward, though, is that at current yields, bonds do almost nothing for investors in terms of providing current income. Bonds will be able to perform the way they have in the past only if yields keep trending lower. Although Europe's bond yields have gone negative, there's still only so far investors can expect Treasury yields to fall before bouncing back upward.

Naysayers about bonds have been wrong for a long time, and it's possible that they'll be wrong again. Nevertheless, if the coronavirus-led downturn in the stock market turns out to be short-lived, the success that bonds have had recently could reverse itself quickly -- bringing a nasty surprise to those who thought Treasuries were conservative investments that could never lose money.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

iShares Barclays 20+ Year Treasury Bond Fund Stock Quote
iShares Barclays 20+ Year Treasury Bond Fund
$101.98 (-0.56%) $0.57
Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$30,273.87 (%)

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 10/07/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.