by Robert E. Quittner, Jr. CFP® & CMFC™
Investment Advisor Representative
[email protected]
With all the focus on the stock market, tariffs, DOGE, Tesla dealerships, eggs, plane accidents and Ukraine, I’ll go in a different direction today.
A traditional investment portfolio typically consists of a mix of stocks, bonds, and cash with the goal of balancing risk and return based on an investor’s time horizon and risk tolerance. While we often discuss the stock market, today I’ll delve into the bond arena.
When discussing stock market returns, people often reference the S&P 500, Dow Jones Industrial Average, and/or the Nasdaq. In contrast, when evaluating bond performance, the Bloomberg U.S. Aggregate Bond Index (commonly called the “AGG”) has become the preferred benchmark. Created in 1976, the Agg serves as a key tool for fund managers and investors to assess bond market performance. It is a broad-based index that represents the U.S. investment-grade bond market, comprising a diverse mix of bonds varying by issuers, maturities, and risk levels.
The index consists of the following major categories:
- U.S. Treasury Bonds – Government-issued debt securities.
- Mortgage-Backed Securities – Bonds backed by pools of mortgages, including those from Ginnie Mae (GNMA), Fannie Mae, and Freddie Mac.
- Corporate Bonds – Investment-grade debt from U.S. corporations.
- Asset-Backed Securities – Bonds backed by financial assets like auto loans and credit card debt.
- Municipal Bonds – Some state and local government bonds.
Now that we’ve covered the benchmark let’s explore the primary factors that influence bond performance.
- Interest Rates (Federal Reserve Policy)
- Inflation
- Economic Growth
- Credit Risk
Interest rates and Federal Reserve policy are key drivers of bond prices. When the Fed raises rates, bond prices – especially those of longer-duration bonds – typically decline, while rate cuts tend to push prices higher. We just experienced this over the last 3 years (02/28/22 – 02/28/25) as the Fed aggressively hiked the Federal Funds Rate. During this period the U.S Aggregate Bond Index (AGG) dropped 9.42%, illustrating the significant impact of rising rates on bonds.
In response to the 2008 Financial Crisis, the Federal Reserve introduced Quantitative Easing (QE) as a new monetary policy tool. Traditionally, the Fed relied on adjusting the Federal Funds Rate to influence interest rates, control inflation, and stimulate or cool down economic activity. However, when interest rates were already near zero after the crisis, the Fed needed an alternative way to inject liquidity into the financial system and stimulate economic growth.
How exactly does QE Work? It involves the large-scale purchase of financial assets, primarily:
- U.S. Treasury Bonds – Government-issued debt securities that help lower long-term interest rates.
- Mortgage-Backed Securities (MBS) – Bundled home loans that, when purchased, help support the housing market by keeping mortgage rates low.
The Fed has used this program 4 times including between 2020-2022 in response to the Covid-19 pandemic. In this case they went a step further and purchased corporate bonds and bond ETF’s. We could dive much deeper into monetary policy, but since this is meant to be a light Friday morning read, let’s shift our focus to the historical impact on the bond market. As the saying goes, a picture is worth a thousand words, and the chart below offers a clear snapshot of bond returns going back to 1976.
This chart illustrates U.S. Aggregate Bond returns over the last 49 years. If we cut this chart in half and look at 1976-1999 versus 2000-2024, there is a drastic difference in average bond returns. Correspondingly the averages are 9.01% versus 3.14% which is significant! After the Fed added QE to its toolkit in 2008, the annual average dropped further to 2.9%.
Will we ever return to the historical bond performance of the 1980s? We don’t know for sure, and I don’t profess to be an economist. Generally, there are economic factors which have changed since the 80’s which could make it unlikely:
- Fed’s Policy Approach – The Fed is now much more proactive in managing inflation, aiming to prevent the kind of runaway inflation seen in the 1970s.
- Structural Changes – Today’s economy is far less inflationary due to globalization, technological advancements, and demographic shifts.
- Debt Levels – The U.S. government and businesses hold significantly more debt today, making extremely high interest rates economically unsustainable.
- Demographics & Productivity – Slower population growth and productivity gains reduce the likelihood of sustained high inflation.
We often discuss investment allocations in terms of money at risk vs. safe money. Bonds, while generally considered safer than stocks, still fall into that risk bucket due to their downside exposure as illustrated above. If you’d like a current assessment on your Risk/Safe money balance let us know and we can schedule a meeting.
We are 6 days away from spring. Enjoy your weekend!
Rob