A Brutal Bond Market

The bond market has been experiencing a brutal period, according to recent data from the Bloomberg Aggregate Bond Index. This index, established by Lehman Brothers in the early 1980s, tracks the investment-grade taxable bond market and includes Treasuries, corporates, mortgage-backed securities, and asset-backed securities. Currently, the index represents over 10,000 fixed-income securities.

The Agg has become the benchmark for most active fixed-income managers to measure their performance. It also serves as a proxy for total bond market index funds. However, the returns over the past five and ten years have been among the worst in history. The rolling five-year returns for the Agg through the end of August have been negative for the first time in the index's history.

The current 10-year real returns are as bad as they've ever been, with inflation-adjusted performance reflecting a lost decade for bond investors. This is worse than the early 1980s, when inflation ran in the double-digits. The worst return in the late 1970s, when the Agg was up 1.4%, was in 1978; prior to that, the index had a down year only once between 1976 and 1993.

The bond market is particularly brutal compared to the late-1970s and early-1980s. From 1976 to 1981, there were no down years for the Agg, with the first down year not occurring until 1994. In the late 1970s, the worst return was in 1978 when the Agg was up 1.4%. However, this was nominal, and inflation was much higher back then. In 2022, the Agg had its first double-digit down year, falling 13%. The 2021 and 2022 down years marked the first consecutive down years in the Agg's history.

The bear market that began in 2020, when rates bottomed, resulted in the worst drawdown in history for the Agg, with a nearly 20% decline. The three main factors contributing to the poor bond returns were low starting yields, rapid interest rate increases, and high inflation. While yields are now higher, the relationship between starting yield to maturity and forward 5-year returns has broken down this decade, with returns even underperforming the yield expectation.