Apologies for the tardiness of this month’s commentary. I am going to be completely honest and admit that I was really struggling for inspiration. This last month there really has been one, and only one, topic on the minds of investors and it’s a topic that I did not really want to write about. But write I shall, and thus, with a minor delay, here we are again.

The title of this month’s commentary is both literally appropriate and yet figuratively ironic – a rare and, I must say, satisfying combination. Its literal appropriateness is, I should think, self-evident. For the war in the Middle East and the peace that markets are desperate to price, have once again dominated the conversation. The irony relates to the juxtaposition between what is set to be a rather shorter than usual musing, and Leo Tolstoy’s famously gargantuan tome.

The last few months have been a whirlwind of military attacks, blockades, ceasefires, negotiations and public bickering. It would really take a person of monumental positivity to claim the world looks or feels a better place today than it did on the 27th February. However, for many major financial markets that seems to be the message that is being sent.

I really do not want to get into the weeds with respect to the war itself. From the outset it has been very difficult to assess because the goals, intentions and incentives from the US side are so poorly understood. From the Iranian side, it is clearly, at its heart, a battle for regime survival. Understanding the views of the population at large, and thus the potential for internal political pressure, is nigh on impossible in the current environment. To make matters even more complex, the killing of numerous senior leaders within the political and theocratic spheres means that our understanding of key personnel and personalities is partial at best. Throw in the known division between the purported political decision makers, a new Supreme Leader and the de-centralised and decapitated Islamic Revolutionary Guard Corps (IRGC) and you have a recipe for opacity and uncertainty.  

Markets have not been restrained by these facts. Knowledge is thin on the ground but that has not prevented a significant recovery in markets. US equities have rallied quickly and aggressively. One of the most rapid rallies from local low, to all-time high in history. That is quite a comeback. But it is not really backed up by sufficiently significant good news, in my opinion. It is absolutely true that, because earnings forecasts have risen so much in the intervening period, P/E multiples look significantly cheaper than before the conflict began. But I learned long ago to expect such things from equity markets. We are living in the age of dip-buying, auto-enrolment and Robinhood. This is not the market of my youth and I’m pretty sure Benjamin Graham – that ‘father of value investing’ – would be at a loss.

In sleepy old bond land, however, it has been a less dramatic turnaround. Although not entirely, I must say. Much of the emerging market bond world has indeed fully recovered all its war-related losses and, in some cases, gone further.

In the G10 nations though, yields remain above their pre-war levels. That has led to some reheating of the recent trope that “bonds don’t provide any protection anymore”.

It is understandable (though in most cases unforgivable) to think such things at such times. But let me assure you that it is really not true (or at least it is a generalisation, a simplification and a disservice). Here are five reasons why:

1. What you buy is what you get. If you buy a high-quality government bond with no default risk, and hold it to maturity, then (plus or minus reinvestment risk which is pretty minimal) the return you will achieve is the yield to maturity at the time of purchase. So, if you buy a bond which matures in one year that yields 4%, then your one-year return will be very close to 4%. And that is whatever equities do. That sounds like diversification to me, and if equities have a swoon, then it will look like protection too.

2. Judging the relative performance of different assets over a period of a few hours or days is a mug’s game. What matters is how your assets perform over more realistic investment horizons. The role of bonds in a portfolio is still being written.

3. We already know that the correlation between bonds and equities has historically tended to ‘flip’ when inflation is high. When inflation is high and central banks are forced to hike rates, most, if not all, financial asset prices tend to fall. This not the same as saying that bonds no longer have value in a portfolio context (also see point 1).

4. Feedback. This is a big one in my opinion. Safe bonds (think government-issued, mostly) have a negative feedback relationship with their drivers. That is to say that when bond prices fall, yields rise. So, if the economy slows, bond yields fall (and prices rise). And vice versa. If the economy improves, growth and inflation expectations rise, investors sell bonds to buy equities. This pushes bond prices down and yields up… rising yields then act to slow the economy. There is an inherent correction mechanism. Equities however have a positive feedback relationship with their drivers. When equity prices rise, consumers feel wealthier, they spend more, that increases the earnings of companies, which pushes up equity prices. When the recession cometh, it all goes into reverse. And usually very, very rapidly. That is great during the bull run, but unforgiving when a bear market hits. That is why equity markets go up the escalator and down the elevator.

5. The ‘why’ and the ‘how quickly’ matter for the behaviour of bonds in response to conditions in riskier markets, just like they do for equities.

So do not throw your bonds out the window just now. In fact, consider doing the opposite. The cheapest time to buy anything is when its on sale. And in investing terms, buying cheap is a tried and tested way to improve long-term returns.

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James Athey is Co-Manager of Marlborough's Global Bond & Global Corporate Bond funds.

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This article is provided for general information purposes only and should not be construed as personal financial advice to invest in any fund or product. These are the investment manager’s views at the time of writing and should not be construed as investment advice. The opinions expressed are correct at time of writing and may be subject to change. Capital is at risk. The value and income from investments can go down as well as up and are not guaranteed. An investor may get back significantly less than they invest. Past performance is not a reliable indicator of current or future performance and should not be the sole factor considered when selecting funds.