The good news hidden in the bond market’s 2021 losses

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It’s good news that the bond went down last year.

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I suspect you reacted like this when reviewing the 2021 performance scoreboard, of course. The overall US domestic bond market declined 1.9% last year, according to the Vanguard Total Bond Market ETF BND.
-0.22%,
Long-term Treasuries lost even more, losing 5.0% (as determined by the Vanguard Long-Term Treasury ETF VGLT,
-0.68%
You might think it’s hard to put lipstick on this pig.

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Reason I think we should try: Bonds are a diversified addition to your retirement portfolio—reducing the volatility-based risk otherwise associated with an all-stock portfolio. But being a diversifier means they should zag when stocks zig and vice versa. And that’s exactly what he did last year.

Those who were disappointed with Bond’s performance last year want their cake to be and eat it. But it’s magical thinking: You can’t expect shackles Both To diversify your portfolio And That they should go up when the stock goes up. Considering that the stock market performed so well last year—up 25.7%, as seen by the Vanguard Total Stock Market ETF VTI,
-0.39%
—so it should not come as a big surprise that bonds struggle.

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There’s another way in which bonds struggled last year is good news: It counters a narrative that emerged at the start of the pandemic that there was a more or less permanent increase in the stock-bond correlation. According to that narrative, interest rates had fallen so low that they had nowhere to go but to go up. If so, investors may be joking in the hope that the bonds will offset any downturn in the stock market.

In light of what happened last year, it now appears that the positive stock-bond correlation in early 2020 was a temporary phenomenon. This is shown in the attached chart, which shows the past six months’ correlation between the total stock and total bond markets. Note that, although this correlation reached very high levels in early 2020, it has since returned to earlier levels.

60:40 Hope for the Portfolio

The return of negative stock-bond correlation suggests that it would be premature to throw the towel on a 60% stock/40% bond portfolio — perhaps the most popular asset allocation used by retirees.

You may still have some reservations, given that interest rates – even if they are not as low as they were in the early stages of the pandemic – are very low by historical standards. But research by Portfolio Solutions Group, a part of AQR Capital Management, has found that low rates are not — in themselves — a reason to give up hope and belief that the bond might be a good diversification.

The study, which I first wrote about last May, urges us to focus on how far interest rates can move in any given 12-month period. Only if you think rates can’t drop much enough — 50 basis points or less — should you question the bond’s ability to make a good diversification. Bonds hold close to their full diversification potential as long as you consider that rates are likely to drop by at least 100 basis points.

This precondition has been fulfilled at present. Rates have been 100 basis points lower than they are today in the past 18 months. In fact, the 10-year Treasury yield is currently at 1.76%, 125 basis points. higher Compared to where it stood in the summer of 2020.

Mark Hulbert is a regular contributor to Businesshala. Their Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at [email protected],

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