Financial Professionals

July 25th, 2022

Are Bonds No Longer a Good Hedge for Stocks?

Share
Subscribe

The first six months of 2022 were challenging for investors, even those with diversified portfolios of stocks and bonds.

Indeed, one of the most significant ‘issues’ with 2022’s market drawdown has been the atypically tight correlation between stocks and bonds. Consider that in the first six months, an investor with an all-equity portfolio likely performed in-line with someone invested in a 60% stock/40% bond portfolio.1 In the first four months of the new year, long-term U.S. Treasury bonds were off -18% while the stock market dipped into bear market territory. That’s not supposed to happen.

One of the key benefits of a balanced asset allocation of stocks and bonds is to limit downside volatility during sharp equity market pullbacks, and so far in 2022, bonds have failed to deliver. The breakdown in this relationship between stocks and bonds has some investors wondering if bonds are no longer a reliable hedge for stocks.

But I don’t see the first six months of 2022 as an indication for how the relationship between stocks and bonds will play out moving forward. Investors should also recognize that throughout history, there have been several periods – sometimes long ones – where bonds and stocks were positively correlated. Those periods also happened to be ones where there was high inflation uncertainty, i.e., the 1970s and 1980s.

For most of history, however, bonds have been effective at mitigating equity market risk, and they have also helped portfolios generate positive returns during periods when equities sold off sharply. During the past 20 years, for instance, there has been a consistently negative correlation between stocks and bonds, with basically the only exception being 2013’s “taper tantrum” when both declined in lockstep.2

As readers can see in the table below, long-duration U.S. Treasury bonds have held up remarkably well – and almost always delivered positive performance – during the biggest equity market drawdowns. 2022 is arguably the exception, not the rule.

PeriodCumulative Stock Market Return (S&P 500)Cumulative Long-Duration US Treasury Bond Return
November 2007 – February 2009-50.9%+16.0%
August 2002 – September 2002-44.7%+28.5%
December 1972 – September 1974-42.6%-6.0%
September 1987 – November 1987-29.6%+2.7%
December 1986 – June 1970-29.3%-8.0%
January 1962 – June 1962-22.3%+4.0%

Source: Morningstar, UBS3

Some have argued that an inflation rate of 2.5% is the point at which stocks and bonds flip in correlation from positive to negative or vice versa. During high inflation regimes, bonds suffer as coupon payments become less valuable and as investors demand higher yields, and stocks suffer from lower expected growth rates and cost pressures. High inflation can thus hurt both asset classes.

Expectations for higher-than-average inflation does not mean it’s time to abandon bonds in an investment portfolio, however. The fixed income portion of a portfolio can still serve the purpose of generating cash flows and mitigating equity volatility risk, especially when the bonds in a portfolio are actively managed as we do here at Zacks Investment Management.

For the past couple of years, we have held a fairly cautious stance on fixed income as we anticipated rising rates, and with the Fed likely remaining hawkish for the rest of the year, we have decided to keep duration on the shorter end while focusing on higher credit quality bonds. This type of active management is needed, in my view, to navigate the changing market environment but also to ensure a fixed income allocation is serving its purpose.

Bottom Line for Investors

The first six months of 2022 were a rocky stretch, no matter how investors were positioned. Seeing stocks and bonds move in lockstep downward was a break from what we’ve experienced in the last two decades, when the two asset classes were consistently negative in correlation.

Looking ahead, it is possible that a positive correlation between stocks and bonds could persist in a high inflation regime, which I think argues for the type of active management in fixed income we do here at Zacks Investment Management.

Disclosure

1 Strategas, June 17, 2022.

2 UBS, https://www.ubs.com/global/en/asset-management/global-sovereign-markets/overview/stock-bond-correlation.html

3 UBS, https://www.ubs.com/global/en/asset-management/global-sovereign-markets/overview/stock-bond-correlation.html

DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.

The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks, as well as limited partnership interests. The index includes all Nasdaq-listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debenture securities. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Dow Jones Industrial Average measures the daily stock market movements of 30 U.S. publicly-traded companies listed on the NASDAQ or the New York Stock Exchange (NYSE). The 30 publicly-owned companies are considered leaders in the United States economy. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.
READ PREVIOUS
3 Factors That Could Bring Down Inflation in the Months Ahead
READ NEXT
What Q2 Earnings Are Telling Us

Explore the Archives

Financial Professionals
August 9th, 2022
3 Economic Indicators to Watch in the Second Half of 2022
Read more
Mitch on the Markets
July 29th, 2022
What Q2 Earnings Are Telling Us
Read more
Financial Professionals
July 25th, 2022
Are Bonds No Longer a Good Hedge for Stocks?
Read more
Financial Professionals
July 18th, 2022
3 Factors That Could Bring Down Inflation in the Months Ahead
Read more
Financial Professionals
July 12th, 2022
Are We in a Recession? Depends on How You Define It…
Read more
Financial Professionals
July 5th, 2022
3 Essential Reminders for Investors in a Bear Market
Read more

Subscribe to Mitch on the
Markets and never miss a post.

Top

Search

Contact

I'm a Private Client I'm a Financial Professional