One Big Risk

September 9th Weekly Market Update

When Lehman Brothers filed for bankruptcy on September 15, 2008, defining the seminal event of the financial crisis, there was one big risk investors were worried about across their portfolios: credit risk — the potential losses arising from the inability of mortgage borrowers, financial institutions, and government enterprises to pay back their debts. As we reach the five-year anniversary of that event this coming weekend, another single big risk has emerged in the minds of investors: interest rate risk — the potential losses from rising interest rates on financial assets. While not worthy of anywhere near the same degree of concern as five years ago for most investors, all market participants have been focusing on this traditionally bond-market-centric risk.

Of course, for bond investors, rising interest rates mean falling bond prices, while declining interest rates mean rising bond prices. In general, the prices of longer-term and lower-yielding bonds have the greatest interest-rate sensitivity. Over the past four months, the sharp rise in the yield on the 10-year Treasury from 1.6% on May 2 to 3.0% on Friday of last week has resulted in losses for many high-quality bonds. But it has been no picnic for other asset classes either. For much of the past five years, high-yield bonds have acted a lot more like stocks than bonds, measured by statistical correlation. However, the rise in rates this year has reminded high yield bondholders that they are still bonds, as they have tracked the losses in bonds since May 2 rather than the gains in stocks.

For the full article: One Big Risk