The stock market is off to its worst start in years, down more than 10% so far. That’s still historically a mild correction (10% corrections average one every couple years), but we are hearing from clients that this one feels different. Is it the threat of an escalation to the war in Ukraine? Is it soaring inflation? Have we grown accustomed to stocks only going up?
While these factors can contribute to a feeling of anxiety, there is a more likely culprit. This year’s correction feels worse because bonds aren’t doing what they should be doing when stocks go down. They are falling in lockstep with stocks.
The chart below shows every 10% stock market correction since the Great Financial Crisis (we’ve had 7 in 12 years). Notice that in every instance, bonds were up when stocks were down. Except this year. With a significant rise in inflation (coupled with very low rates to begin with), bonds are off to their worst start in nearly 40 years.
While this year’s stock market correction is thus far one of the mildest since the Great Financial Crisis (2nd lowest negative return), the return for a 60/40 stock/bond portfolio is one of the worst (2nd highest negative return) due to the hit bonds are taking. For instance, this year’s return for a 60/40 portfolio is worse than in 2018, when stocks fell by nearly twice as much. Bonds have simply not provided the diversification we’ve come to rely on as the cornerstone of a 60/40 portfolio.
The good news with bond PRICES falling is that bond YIELDS are now significantly higher. A 10-year Treasury bond now pays close to 3% (versus just 1.5% to start the year, and 0.5% immediately after COVID). The higher the yield, the more likely bonds are to provide the insurance you need when stocks fall. While bonds have followed stocks down to start the year, we think most of the pain for bonds is likely over.
If the stock market continues to fall (due to a recession or further global conflicts), we would not be surprised to see bonds return to their role as a diversifier in portfolios.