Some may doubt that a recession’s coming, but the bond market has already made up its mind.
The yield on the benchmark 10-year Treasury sunk to 3.85% yesterday, the lowest in three years. The rush to buy bonds, and thereby lower yields, reflects the growing sentiment that more trouble awaits the American economy. In short, fixed-income investors couldn’t be happier.
The sharp drop in yield brings up the subject of whether the previous low might be revisited. Back in June 2003, the 10-year yield briefly dipped to 3.07%. The dramatic fall in the price of money at the time inspired forecasts that the 3.07% would stand as the low mark for a generation or more. It sounded like a plausible argument at the time. Indeed, a month later, in July 2003, the 10-year yield reversed course and closed the month at 4.47%.
As for today, it’s any one’s guess if a similar rebound is coming any time soon. Meanwhile, the bull market in bonds has boosted fixed-income weights this year. Investors who shunned bonds earlier have paid the price. With U.S. equities suffering, debt has lived up to its traditional reputation as a potent diversification tool.

The difference is striking on a year-to-date basis. U.S. stocks, measured by the S&P 500, are just barely in positive territory this year through yesterday’s close, posting a 0.9% rise. In contrast, the Lehman Brothers Aggregate U.S. Bond Index is up a bit more than 7% year to date.
Foreign bonds are looking even better, in part due to the currency bonus born of a falling dollar. By almost any standard, debt denominated in euros, yen and other currencies have enjoyed a good year. The Citigroup World Government Bond Index, a measure of foreign debt issued by developed nations, has climbed 13.3% this year through yesterday, in unhedged currency terms based in dollars.
It’s interesting to note that foreign developed-market bonds as an asset class were out of favor by more than a little at the close of 2005. Debt from the large economies lost ground that year while equities were flying. In 2006, foreign bonds rebounded some, and the rebound continues as we write.
The lesson once again seems to be that owning a diversified portfolio of the major asset classes (there are 10 by our count, plus cash) is a founding principle for long-term investment success. So too is the logic of favoring asset classes that have fallen on hard times while lightening up on those that have soared.
The great debate is how to weight each of the asset classes, when to rebalance, and so on. On that score, investors who have continued to own bonds now have the enviable challenge of deciding if it’s time to trim their collective weight. Indeed, if you’ve had any bond allocation of substance this year, it’s probably grown as a share of portfolio assets. Meanwhile, the U.S. equity weight may very well have fallen.
Is it time to pare bonds and buy U.S. stocks? Maybe, but we think it’s still a bit early. Of course, we don’t know for sure so there’s a case to start nibbling by way of reweighting the portfolio.
Meanwhile, in the coming weeks and months strategic-minded investors will want to watch the asset classes closely for opportunities. To that end, your correspondent keeps a close eye on fundamental measures such as dividend yields and interest rates, among others, to weigh the prospective opportunities and risks. In that regard, it’s just another day. But with volatility in a new bull market, some days promise to better than others for investors hoping to exploit the rebalancing bonus.