Posted:October 9, 2026
Categories: Bonds
In 1171, when the Venetian Republic was at war with the Byzantine Empire, the elected ruler of the Republic, Doge Vitale II, desperately needed funds to finance his fleet. Normally, funds were raised through taxes, but in this instance, the need was much more urgent. He divided the city into six districts and levied a compulsory or forced loan known as a presiti. In return for their capital, the Venetian government promised to pay 5% annual interest. What made this event historically groundbreaking was that the Venetian state allowed the receipts of the presiti to become negotiable and transferable. And just like that, the first modern government bond market was born.1
It is a striking historical echo that 855 years after Venice anchored the world’s first government bond at 5% interest, that same 5% mark remains a central anchor for global bonds today in the 10-Year U.S. Treasury bond. Yet, the prevailing sentiment today is overwhelmingly bearish on bonds.
Fundamentals of Bonds
The primary function of bonds is to provide stable, contractually defined cash flows through coupon (interest) payments, followed by the full return of principal at maturity. Bonds generate income, while maintaining lower risk (volatility) than stocks. Furthermore, bonds serve as a primary defensive hedge against recessions, economic contractions, and periods of deflation. In the context of the four-quadrant portfolio design framework, bonds are often the best-performing asset class during a deflationary bust.
That being said, bonds can experience long stretches of low, or even negative, real returns, as I show later in this article. The primary risk in bonds stems from periods of high inflation, making them susceptible to reinvestment risk. Further, higher-risk bonds are subject to default risk.
Bonds Role in a Portfolio
One of my primary goals as an allocator of capital is to help clients design a portfolio tailored to their goals, income needs, and, more importantly, their tolerance and capacity for risk. Getting this right for each client and situation is no easy task. But if we get risk tolerance dialed in correctly, holding less volatile assets than stocks can help guard against panicking and selling equities during inevitable stock market crashes.
In the context of a diversified portfolio, holding an allocation to bonds (or cash) can act as a stabilizer during economic growth shocks. Assuming interest rates drop during a deflationary event, bonds can provide a buffer for investors when stocks fall, helping prevent them from selling at the bottom of a market downturn. Because bonds carry lower risk (volatility) than stocks, investors can dial in their overall portfolio risk target.
Historical Bond Market Performance
From a historical perspective, the recent past has been challenging for bond investors. Figure 1 is a chart showing the rolling 10-year annualized nominal total returns for U.S. bonds, dating back to 1793. A few things stand out:
Figure 1: Rolling 10-Year Annualized U.S. Bond Nominal Total Returns Since 1793
Source: Bianco Research LLC
Recent Bond Market Performance
Let’s look more closely at bonds since 1980 through the lens of today’s main benchmark: the U.S. Bloomberg Aggregate Bond Index.
These charts show that investors should be cautious about selling or ignoring bonds when recent returns have been awful. Historically, extreme troughs precede rallies because low bond prices equal higher starting yields.
Figure 2: Bloomberg Aggregate Bond Rolling 10-Year Returns since 1985
Source: Ben Carlson (The Compound)
Figure 3: Bloomberg Aggregate Bond Rolling 5-Year Returns since 1980
Today’s Market
With today’s starting yields, bonds look more attractive. That being said, I am certainly not calling for the return of the 40-year bond bull market that ended a few years ago. I believe those days are gone. No one can predict where interest rates and bond prices are headed. However, it’s important to stay level-headed as an investor. Rolling returns look backward through the period when interest rates went from 0% to 5%. Forward returns look ahead from a starting yield of roughly 5%. Starting yields are the strongest predictor of forward multi-year returns.
Remember that there is an inverse relationship between interest rates and bond prices.
When starting yields are near 5%, this steady income acts as a cushion for a portfolio. If interest rates were to rise, pushing bond prices down, the income generated by today’s higher yields would offset those price declines. For short-term bonds, which are less sensitive to rising rates, the income cushion has historically been sufficient to maintain positive overall returns in a rising interest-rate environment.
Conversely, if interest rates fall, bond prices rise. In a falling interest-rate environment, investors benefit not only from their attractive starting yields but also from price appreciation. This price movement is magnified with longer durations, such as the 10-year or 30-year U.S. Treasuries. While longer-term bonds experience steeper price declines when rates rise, they also offer the greatest price appreciation when rates fall.
Conclusion
The bond market remains the ultimate arbiter of global macroeconomics, exercising a discipline over government policy that political strategist James Carville famously summarized when he quipped:
“I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.” James Carville2
Today’s sentiment couldn’t be more negative on the bond market. I’ve certainly written and discussed my dissatisfaction with out-of-control fiscal spending and high debt levels globally. I also believe that we’re squarely in an inflationary regime. That said, as I survey opportunities in today’s markets, bonds once again are starting to look attractive. Can interest rates keep rising in the United States? Yes, of course. Are yields rising globally? Absolutely. But investors must decide how to allocate capital with the hand they’re dealt. And looking back over 850 years of financial history, a 5% starting yield has traditionally served as a valuable stabilizer for a diversified portfolio, offering investors significantly better downside protection today than during the recent zero-interest-rate era.
References
DISCLOSURES & INDEX DESCRIPTIONS
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