Please ensure Javascript is enabled for purposes of website accessibility

When Stocks Swoon, Is the Bond Market a Good Bet?

By Dan Caplinger - Jan 14, 2021 at 5:53PM

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

Fed officials are hoping for the best, but the truth is more complicated.

Thursday was another up-and-down day for the stock market. Initially, major benchmarks moved up, seemingly threatening their record levels as investors focused on the prospects for potential stimulus measures. However, news that the incoming Biden administration might push tax rates on investments higher seemed to take the air out of the rally. The Dow Jones Industrial Average (^DJI 0.60%), S&P 500 (^GSPC 0.95%), and Nasdaq Composite (^IXIC 0.00%) didn't post major declines, but they remain below their all-time highs.


Percentage Change

Point Change




S&P 500



Nasdaq Composite



Data source: Yahoo! Finance.

Some investors are looking at the stock market and thinking that it might be time for a correction. The bond market has often served as a good alternative for those trying to keep their money working outside stocks. Yet with current conditions the way they are, it's fair to wonder whether bonds will fulfill their historical function -- or end up not being nearly as safe as some investors think they are.

What's happening with the bond market?

Bond investors are always worried about interest rates, and so today's comments from Fed chair Jerome Powell were directly on point. Powell said that he doesn't expect that current low interest rates will need to rise in the near future. In fact, he warned that trying to boost interest rates too quickly even if the economy starts to rebound could be disastrous.

Mosaic in form of percentage sign against a dark gray backdrop.

Image source: Getty Images.

Today's comments were designed to try to put bond investors at ease. Powell indicated that the Fed would need to be very careful about making policy changes, because markets tend to react sharply to even the slightest change in the central bank's moves with respect to monetary policy.

The Fed has more direct control over short-term interest rates. However, to influence the long-term rates that govern key aspects of the economy, such as mortgage lending rates, the Fed has to take more extraordinary action. For years now, the Fed has made asset purchases, buying long-term government and mortgage-backed securities and thereby using market mechanisms to keep those rates lower than they'd otherwise be.

That practice was quite effective in 2020, sending long-term Treasury bond rates to their lowest levels in decades. However, since July, 10-year rates have risen from around 0.5% to above 1.1%. Rates are up almost two-tenths of a percentage point in less than two weeks.

Small moves, big money

Such a tiny rise in rates might not seem like a big deal. But small rate movements can cause big changes in bond prices. Consider: Since the beginning of the year, rates on 30-year bonds are up from 1.65% to 1.87%. Yet the price of the iShares 20+ Year Treasury ETF (TLT 0.40%), which owns those and similar bonds with long maturities, has fallen more than 4%.

A 4% decline for a bond ETF isn't necessarily a huge move. But many investors think that bonds aren't supposed to go down at all. Meanwhile, they point to the long-term gains that bond ETFs have posted recently, not realizing that much of those gains have come from price appreciation that resulted from the plunge in interest rates over the years.

Even interest rate stability would crush the total returns that many bond investors have gotten used to seeing. Interest alone on Treasury bonds amounts to less than 1% for most maturities. That's a far cry from double-digit percentage returns.

Be smart about bonds

Bonds do have a reputation for protecting investors from big swings in the stock market. But right now, bond rates are so low that there's more risk than usual in them. Investors need to be careful before assuming that having money in bonds will protect them from whatever could happen to the stock market in 2021 and beyond.

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 Trust - iShares 20+ Year Treasury Bond ETF Stock Quote
iShares Trust - iShares 20+ Year Treasury Bond ETF
$119.33 (0.40%) $0.47
Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$32,120.28 (0.60%) $191.66
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$3,978.73 (0.95%) $37.25
NASDAQ Composite Index (Price Return) Stock Quote
NASDAQ Composite Index (Price Return)
$11,264.45 (0.00%) $0.00

*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 service.

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 05/25/2022.

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.