The bond market has historically been the go-to asset in times of crisis, in times of fear and in times of chaos. But this time is different, or so it has been this year.
We are surely in a time of crisis, a time of fear and a time of chaos. But the economic backdrop matters and this it’s different in the sense that inflation risk is high and arguably rising (still) — for the first time in decades. The bond market, as a result, is having a tough time navigating what may prove to be a regime change vis-a-vis inflation.
It’s premature to assume that inflation will stay elevated for an extended period. Based on what we know and see right now, however, there’s not much visibility for forecasting a significant pullback in inflation pressures in the near term. That’s not going to change as long as the war in Ukraine rages. When the happy day arrives that the war has ended, a reassessment of inflation risk can begin anew. Meanwhile, the bond market is knee-deep in its worst nightmare.
All of which is a long-winded way of observing that the fixed-income markets, for the most part, remain under pressure. The iShares 7-10 Year US Treasury Bond ETF (IEF), for example, continues to reflect a strong bearish posture. Although the fund posted a gain today, the trend remains firmly negative. The combination of high inflation and a Federal Reserve that appears committed to hiking rates significantly in the months ahead is taking a toll on IEF, along with several flavors of bonds overall.
US corporates are in the same boat, i.e., one that’s taking on water, based on a iShares iBoxx $ Investment Grade Corporate Bond (LQD).
Lest we go to far in painting a completely dark picture, note that inflation-indexed Treasuries are still bucking the trend. The iShares TIPS Bond ETF (TIP), for example, has become a rare port in the storm that’s otherwise roiling fixed income generally. True, TIP is having trouble breaking to new highs, a weakness that bears watching as a possible warning sign. Meanwhile, there’s no confusing this slice of Treasuries with its nominal-priced cousins.
Short-maturity inflation-indexed Treasuries are even stronger, based on iShares 0-5 Year TIPS Bond ETF (STIP). The combination of short-maturities and inflation indexing is the rock star of the moment for bonds.
As for stocks, US shares continue to reflect a weak trend this year, although the market seems to be sitting on the fence as it struggles to price in geopolitical and inflation risks. Vanguard Total US Stock Market (VTI) still looks skewed to the downside, but only moderately so at the moment. The next few weeks could be critical if VTI breaks through its recent low, which would strengthen the outlook for bear-market risk.
By contrast, small cap stocks are showing a defensive posture lately. The iShares S&P Small-Cap 600 Value ETF (IJS) continues to tread water, as it has for much of the past year. A break above $110 would be an encouraging sign for thinking that a new leg up is underway. By contrast, trading below $95 would signal the opposite. For now, however, IJS still looks set to go nowhere fast, presumably on the rationale that more clarity is required vis-a-vis assessing the new world order on the other side of the Ukraine war.
Let’s end on a positive note via iShares Latin America 40 (ILF), which continues to build on its upside momentum this year. This energy-and-materials-heavy portfolio is one of the few broad-based winners for equities in 2022. Headwinds may be brewing as the ETF approaches its high point from a year ago, but year-to-date results — up 25.2% — are especially impressive when gains in equities have become a rare bird overall. ■
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