The strong rise in the stock market, led by big gains in the financials, energy, and industrials sectors, has dominated the news recently. Dubbed by some as the “Trump Rally,” widespread anticipation of less regulation, lower taxes, and pro-growth policies have pushed major stock indexes to record highs. While the most aggressive, risk-on investors have reaped the full scope of these gains, the effects on the retirement and brokerage accounts of the average investor have been more moderate. The reason why is simple.
Unless you are an extremely aggressive or young investor, you most likely have at least a portion of your portfolio invested in bonds. Unfortunately, many of the same factors that have been driving up equities have been pushing down fixed income securities.
The expectations for higher growth and inflation that have propelled equity markets higher post-election have had the opposite effect on fixed income markets. Because interest rates move higher as growth and inflation expectations rise, increased expectations have pushed rates significantly higher in the past month. Unfortunately for the fixed income market, interest rates have an inverse relationship to bond prices, meaning that the recent upward trend in rates has pushed the value of bonds down.
Still, all bonds aren’t created equal. Municipal bonds have actually trailed corporate bonds over the last month. Municipals are exempt from certain taxes, making them more attractive investment vehicles in taxable accounts. Tax cuts, which are largely expected under the Trump administration, would reduce the net tax benefit that these bonds provide, reducing their attractiveness to investors. In anticipation of these tax reductions, some market watchers have begun to sell their municipal bond positions, driving down their price even more than their corporate counterparts.
In light of these recent trends, it may be tempting for the average investor to sell off at least part of their bond holdings and move the money into stocks. Don’t. At the start of this year, the situation was reversed, with the major equity indexes dropping and bond prices surging. At some point in the future, that will be the case again.
Bottom line, despite the recent trends, there is no advantage in chasing short-term trends at the expense of a diversified long-term strategy that factors in an appropriate asset allocation (stocks/bonds breakdown) based on your own goals, objectives, and risk tolerance.