Morningstar - Q2 2023 - 33

But the promise of coupon payments and
an eventual return of one's money gives bonds
a more concrete path to recovery. Consider
how deeply discounted bond prices got in 2022-
and how broadly the pain was felt across sectors.
That itself won't provide an assessment of value,
per se. Even discount bonds could be considered
rich to investors who think that economic
conditions or fundamentals mean their prices
should be even lower and their yields higher.
Even so, most bonds will still mature at a price
of $100 (shorthand for $1,000 per bond). This
functions like a magnet as bond prices converge
to their redemption values at maturity. The
depth of a discount to that number signals how far
it will have to go, regardless of whether today's
price is particularly good or not.
That's why prices for major sectors such as U.S.
Treasuries, corporates, or mortgages that
dominate the U.S. market and the Morningstar
US Core Bond Index (which includes all three)
generally stayed in a range from $95 to $100 over
the 20 years leading up to 2022. The trajectories
and timing of the back and forth often vary
given that, even in the worst economic times,
Treasury bonds typically rally while others
sell off, or Treasuries and mortgages tank while
credit-sensitive assets surge.
What made 2022 different? So many bond
sectors fell to deep discounts at the same time. In
fact, it was the first time in 20 years that all
the major sectors dipped below $90 ( EXHIBIT 4 ).
Is the takeaway that bonds are a screaming
buy? Not necessarily. Nearly 90% of all bonds in
the Morningstar US Core Bond Index have been
trading below par as of late, and it's difficult
to imagine a highly rated bond trading at roughly
91 cents on the dollar going much lower if
one knows that it's going to pay off at 100. That
was the average weighted price of bonds in
the Morningstar US Core Bond Index at the middle
of March 2023. That figure reflects a broad
average across markets and the maturity spectrum,
so let's look at an actual Treasury bond. There
was one at the end of January, for example, that
matured in six years and carried a yield to
maturity of 3.6%. It was priced at roughly $90.
Morningstar US Mortgage-Backed Securities
Morningstar US Treasury Bond
Morningstar US Corporate Bond
Morningstar US High-Yield Bond
Morningstar US Corporate Bond
Morningstar US High-Yield Bond
Core Bond
Mortgage-Backed Securities
Treasury Bond
EXHIBIT 2
-20%
2022 Return
-20%
2022 Return
-15.71
-15
-15
-15.71
-12.99
-11.94
-12.43
-11.94
-12.43
-11.09
-10
Downward Shift After the financial crisis, bond yields stayed at historically tight
levels for a decade.
-11.09
-10
25%
25%
20
20
15
15
10
10
5
12/1999
12/1999
EXHIBIT 3
Investors Run From Bonds 2022 was the worst year for bond-fund outflows since
Morningstar began tracking the data.
$600B
$600B
300
300
-300
1993
-300
1993
2000
Source: Morningstar Indexes. Data as of Dec. 31, 2022.
2007
2014
2022
2000
2007
2014
2022
12/2005
Source: Morningstar Indexes. Data as of Dec. 31, 2022.
12/2005
12/2011
12/2022
12/2011
12/2022
5
Morningstar US
High-Yield Bond
8.99
Morningstar US
High-Yield Bond
8.99
Morningstar US
Corporate Bond
5.40
Morningstar US
Corporate Bond
5.40
Morningstar US
Core Bond
4.65
Morningstar US
Core Bond
4.65
Morningstar US
Treasury Bond
4.18
Morningstar US
Treasury Bond
4.18
Morningstar US
Mortgage-Backed
Securities
4.68
Morningstar US
Mortgage-Backed
Securities
4.68
-5
-5
A pessimist might say that 3.6% is too little to
compensate for a global economy that's still
structurally vulnerable to inflation and that the Fed
isn't reliable enough to keep it from resurging
or bond prices from falling. Were a spate of investor
panic to drive this bond's yield to 4.6% overnight,
one would expect a further drop in price down
to roughly $85 based on its duration (a measure of
interest-rate sensitivity) at the end of January.
An optimist would argue that bond markets are
already assuming that the Fed is being steadfast
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33
Estimated Net Flows
Estimated Net Flows
Morningstar Bond Index Yields
Morningstar Bond Index Yields
http://www.morningstar.com/products/magazine
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