The Value of Bonds in Today's Portfolios

Historically, the 60/40 portfolio was a standard strategy because bonds used to zig when stocks zagged. In today’s market, is there still a place for bonds?

Remembering the Value of Bonds in Investment Portfolios Many investors may remember 2022 as a year when diversified portfolios did not seem to deliver. Stocks and bonds both suffered declines in tandem, as inflation’s upside surprise caused the Federal Reserve to shift quickly from quantitative easing (QE) to quantitative tightening (QT) and aggressively raise the benchmark Fed funds rate from 0.1% to 4.4%. Bonds (10-year U.S. Treasurys) posted two consecutive years of declines for the first time since 1958-1959, and stocks fell -18% in 2022 before recovering the next year. As seen in the charts below, 10-year U.S. Treasury bond yields soared (and prices fell) in the years following the pandemic, while the 7-10-Year U.S. Corporate index (bottom chart) also slid by over -20%. The bear market in bonds coincided with the bear market in stocks. Source: Federal Reserve Bank of St. Louis 1 Source: Federal Reserve Bank of St. Louis 2 The Pitfalls of Market Timing: What Investors Should Know With today’s market swings, it can be tempting to time your investments. However, history shows that attempting to buy low and sell high often leads to costly errors. To help you stay on course, I’m offering our free guide, The Perils of Market Timing 3, which covers: How market timing can impact returns How to avoid the market timing trap: Two steps The bottom line for investors If you have $500,000 or more to invest and want answers to the questions above, click on the link below to download this guide today! Download Your Free Guide: The Perils of Market Timing 3 As a result, many investors heralded the ‘end of the 60/40 portfolio.’ But those who questioned the future veracity of diversified portfolios were getting a key point wrong. Stocks and bonds are not supposed to be perfectly uncorrelated assets, meaning that when one ‘zigs’ the other ‘zags.’ We know this to be the case from history. Looking back at the late 1960s and 1970s, we find an environment when stocks and bonds started moving in the same direction (positive correlation), which was also a time when inflation shocked to the upside (much like 2022). The 1973 oil embargo catalyzed already creeping inflation, and inflation expectations also started to drift higher. Positive correlation between stocks and bonds took hold. It wasn’t until the late 1990s when a negative stock-bond correlation resurfaced, which was also the time when inflation expectations fell back down to more normal/neutral levels (slightly less than 3%). That negative correlation lasted for a little over 20 years, which meant that diversified stock-bond portfolios were largely effective at mitigating volatility and hedging against weak growth. 2024 and beyond looks more like the late 1990s from an inflation perspective than in the 1970s, with inflation expectations anchored around 3% (at least for now). While this may suggest a higher likelihood of a negative correlation between stocks and bonds than a positive one, it’s important to remember that long-term, the correlation between U.S. stocks and bonds is far closer to zero than it is to 1.0. This means the two asset classes basically have no predictable relationship when it comes to directional movement. When one zigs, the other can zig too. Or it can zag. Or neither. The point here is to remind investors that the inclusion of bonds in investment portfolios is not a decision about correlation. It’s a decision about reducing volatility, generating income, or both. History tells us that bonds are reliable income generators, and they also tend to exhibit less volatility than stocks over time, which can be useful for investors with a more conservative risk tolerance. If an investor also has less need for long-term growth and/or a shorter time horizon, bonds can play a crucial role in the asset allocation decision in those cases, too. Bottom Line for Investors Anchored inflation expectations and moderating growth tend to favor a negative stock-bond correlation, which would strengthen a ‘balanced’ portfolio’s ability to mitigate downside capture during a period of weak economic growth. While this outcome is certainly not assured, bonds’ primary role of reducing volatility does seem to be entering a period of normalization. The Federal Reserve’s stated objective of moving the benchmark Fed funds rate to a longer-term “neutral rate”—which I’ve said previously looks like it could be somewhere in the 3.5% range—suggests that bond markets should exhibit lower relative volatility than stocks going forward, given low expectations that interest rates could move sharply in either direction. Source: Federal Reserve Bank of St. Louis 4 In light of these shifts, we’re offering a free guide, The Perils of Market Timing 5, which explores why a disciplined, long-term approach often outperforms attempts to predict market swings. Inside, we address: How market timing can impact returns How to avoid the market timing trap: Two steps The bottom line for investors If you have $500,000 or more to invest, click on the link below to download this guide today! About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. At Zacks Investment Management, we work with clients with $500,000 or more to invest, and we use this independent research, 35+ years of investment management experience, and tools we’ve developed to design customized investment portfolios based on each client’s individual needs. The end result is investment management that is research driven, results oriented and client focused. Talk to a Zacks Wealth Advisor today. © Zacks Investment Management  |  Privacy Policy 1 Fred Economic Data. October 25, 2024. 2 Fred Economic Data. 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