Conventional wisdom teaches that, on a relative basis, bonds are a more conservative holding when compared to equities. That being said, bonds have produced stellar returns for decades—thanks in large part to the taming of inflation and other factors. A basket of stocks would have returned a mere 19 percent from the start of 2000 through 2011, for example, while a basket of bonds would have returned about 113 percent, through a combination of rising prices and interest earnings.¹

Since 1982, the dominant market conditions have been benign inflation and falling interest rates. Instances of deflation and stable rates have occurred—but have been few and far between. Investors have benefited from this secular decline in global bond yields through a steady appreciation in bond prices that has added substantially to total returns. Over the past year, however, global interest rates have fallen not only to their lowest levels of the post-World War II era, but also to their lowest levels since the Great Depression.²

U.S. Federal Reserve Chairman Ben Bernanke and the central bank have promised to keep interest rates near zero until at least mid-2015. Only time will tell if this promise will be kept, as Bernanke’s term as chairman ends in January 2014. The Fed—mandated to keep inflation in check—could be forced to raise interest rates sooner than expected. Rising interest rates can be very hard on investors who already own bonds or bond mutual funds because these rates drive down the value of the older bonds that pay less, potentially creating substantial losses. A 30-year bond can lose 10 percent of its value for every 1 percent point rise in prevailing rates.³

The Fed’s problem—running out of ways to stimulate the economy—means that Treasury yields have effectively hit bottom or at least come so close that in the long run the odds of rates dropping further appear to be vastly outweighed by the odds of rising yields. The reversal of this 30-year sustained trend will significantly alter the widely accepted conservative risk profile of the once “high-quality,” longerduration fixed-income market. The upshot? It may be time to throw out your old investment textbooks.

^{1, 3“}The End of the 30-year Bond Bull Market,” Knowledge@Wharton (March 28, 2012); ²“Fixed Income—Where do we go from here?” Titan Advisors LLC (Fall 2012); ⁴Warren Buffett (2002)
Jonathan T. Swanson is a Private Wealth Advisor with the Wealth Management division of Morgan Stanley in West Des Moines, IA. The views expressed herein are those of the author and may not necessarily reflect the views of Morgan Stanley Smith Barney LLC, Member, SIPC, www.sipc.org. Morgan Stanley Financial Advisor(s) engaged Worth to feature this profile. Jonathan T. Swanson may only transact business in states where he is registered or excluded or exempted from registration www.morganstanleyfa.com/swanson. Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where Jonathan T. Swanson is not registered or excluded or exempt from registration.