Announced earlier this week, U.S. job growth in May 2018 vaulted payroll gains above 1 million in 2018, reaching the milestone a month earlier than in the past two years. Employers added 223,000 jobs last month, more than forecast and bringing payroll gains for the year to 1.04 million. The jobless rate fell to 3.8 percent to match April 2000 as the lowest since 1969, moving further below the 4.5 percent Federal Reserve officials see as sustainable in the long run.
The strong labor market is expected to keep powering economic growth, and the data reinforced expectations for Fed policy makers to likely raise interest rates at their meeting on June 12-13. The probability of two more hikes this year, rather than one, seems to be inching up as well.
Following the release of the report, equities promptly rallied while the yields on both the 10 year Treasury Note and 30 year Treasury bond rose. Since yields and bond prices move in opposite directions, bond portfolios suffered a sharp decline.
Future Wealth’s View
While equity markets clearly benefit from strong economic data, in the bond world, things are little murkier.
If one is holding individual bonds rather than a bond fund, bonds typically make twice-yearly “coupon” (or interest) payments. If the bonds are held to their maturity date, the principal amount, also known as the face or par, value is returned. In the meantime, the price of the bonds can increase or decrease and it hardly matters to the holder of the bonds. Bottomline – with individual bonds, unless the issuer defaults, principal is given back at maturity no matter what rates do in the interim.
Bond funds, on the other hand, include numerous bonds with a variety of maturity dates and income payments. Unlike individual bonds, which pay interest every six months, bond funds’ coupon payments are distributed to investors on a monthly basis and can be paid or reinvested to boost returns. Most bond funds also don’t have a set maturity date—their bonds are periodically maturing or being bought and sold. This is where things tricky. As a holder of a bond fund, there is no way to know when is right time to buy more or sell the position. And there is also no guarantee that you’ll recover your principal at a specific time—particularly in a rising-rate environment.
At Future Wealth, with rising interest rates, we are over weight in equities in our client portfolios and tend to prefer dividend paying and value stocks over bonds. We will be paying close attention to the next jobs report as it could put another dent in bond prices and take equities higher, whether or not President Trump jumps the gun and tweets an hour before jobs report is formally released.