You may remember a year ago that most of the market gurus were saying that 2004 would see solid returns for the stock market but a problem for the bond market because of an expected rise in interest rates.
Well, what happened? There was a bit of struggle in the stock market last year although the returns were still solid enough. The S&P 500 showed an 8.4 percent gain, a little less than predicted, and the stocks of smaller companies, with the Russell 2000 as a benchmark, increased by some 16 percent.
What kept the stock market at bay somewhat last year were increased energy prices, terrorism, Iraq, and the U.S. presidential election. All understandable.
Now what about the bond market?
According to Kathryn Head, president of First Investors, the bond market has posted solid results. "The high yield sector has generated the highest returns for the second consecutive year, reflecting an improving economy, low and declining default rates, and substantial investor demand." She also points out that for similar reasons, investment grade bonds have also provided solid returns.
The reasons for such results? It's been said that although the rate of inflation has risen, it is still considered rather low based on history. Next, bond investors have been pretty much reassured by what the Federal Reserve has been doing with its tightening of short-term interest rates in order to obviate inflation, and the Treasury market has been the recipient of the increased demand on the part of foreign investors.
So, what do we have for this year? It's pretty much what it was a year ago. Most experts predict that stocks will continue to rise and this is based on a slower (but still strong) growth of corporate profits plus the large cash that is held on corporate balance sheets, which could be earmarked for acquisitions, larger dividends, or stock buybacks. Of course, watch one aspect here. If both short- and long-term interest rates increase this year, that could work negatively on the bond market.
Clearly, it becomes a bit of a crapshoot. Those investors who ran away from bonds this past year didn't pick up some good returns and by the sane token, those who stayed from equity funds because of terrorism and geopolitical risks, might have just missed the recent rally.
Interesting, eh? To say the least.
