What did people get wrong in 2014?
By far the most popular wrong-headed call last year was on interest rates. In late 2013 almost all market-watchers predicted that a stronger US economy and more restrictive Federal Reserve would lead to rising bond yields. Boy, was that a mistake. A year ago 10-year Treasury Notes yielded almost 3%. Now they yield 2 1/4%. So while the stock market in the US has grown by 15% this year, treasuries have risen 5%, corporates 7%, and muni bonds returned almost 9%.
10-year US Treasury Yield:
Part of the reason is supply and demand. As the economy has improved, federal, state, and local governments haven’t needed to borrow so much. A bond shortage has raised bond prices. Part of the reason has been sluggish growth in the US. In the first half of the year, nasty weather flattened the economy, while in late 2014 falling oil prices sparked geopolitical fears and concerns about credit. But a big reason has been the Fed’s conservative stance. They’ve been reluctant to rock the boat.
So are we in for another wrong-way interest-rate call? It’s certainly possible. So many market mavens think the Fed will rates in 2015 that expecting steady Fed policy next year is certainly a contrarian call. Nevertheless, we do expect tighter money and higher interest rates. An expanding economy should allow the Fed to begin moving rates back to normal—something they have said they want to do. And the Fed usually gets what it wants.
Does that mean investors should ditch bonds? No, disciplined investors need to stay diversified. Bonds provide stability in an uncertain world. Even when rates are low—especially when rates are low—return of capital can trump return on capital. Predictions are interesting, but we just don’t know the future.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!