Bonds have failed to hedge swings in stocks since 2022, dragging down portfolios, Morningstar said.
The classic 60/40 portfolio has seen its worst performance in 150 years, a study from the firm showed.
But diversification remains key despite bond struggles, says Morningstar’s Emelia Fredlick.
When stocks falter, investors often hope that bonds can provide a solid buffer against the volatility.
Usually, this proves to be the case, but for the first time in the last 150 years, bonds haven’t behaved like the safe-haven hedge that investors have grown to rely on, and it’s dragging down overall portfolios.
Investing giant KKR pointed to this dynamic earlier in the year, noting that government bonds aren’t acting like “shock absorbers” anymore.
A report from Morningstatrthis week confirms that view.
According to a study from the firm published on July 11, the classic 60/40 portfolio — with 60% in stocks and 40% in bonds — has seen its worst performance in a century and a half over the past few years. In this case, stocks are represented by the S&P 500 and bonds by the 10-year Treasurys.
“The 2020s were the only market crash of the past 150 years when the decline experienced by a 60/40 portfolio was more painful than the decline experienced by an all-equity portfolio,” the firm said.
The study goes back to when equities began their bear-market plunge in January 2022. While stocks plummeted due to recession fears, bonds also suffered a brutal rout as the Federal Reserve embarked on one of its most aggressive rate-hike sprees in decades.
Though stocks have recovered to new highs since then, bonds still haven’t fully emerged out of that bear market, and it’s pulled down overall portfolio performance.
According to Morningstar, the stretch since 2022 is the sole instance since at least 1870 in which bonds haven’t provided a buffer for a significant decline in stocks.
Despite the underperformance on paper, it should be noted that bond-price declines are only realized if the asset is sold before its maturity date. If held to maturity, the principal is still protected and the bond still yields its fixed rate.
Usually bond prices appreciate when stocks decline as investors seek safety. This allows investors the chance to sell them at a profit if they wish.
Even though the 60/40 has undergone a rough patch, Morningstar’s Emelia Fredlick, a senior editor and the study’s corresponding author, said that taking a diversified approach to portfolio construction is still worth it.
“In aggregate, a 60/40 portfolio experienced 45% less pain than an all-equities portfolio during the stock market crashes of the past 150 years,” Fredlick wrote.
For example, while the S&P 500 fell 79% during the 1929 crash, the 60/40 portfolio dropped 53%.
“The 60/40 portfolio softened the blow of nearly every market crash: A couple of the episodes on our original timeline of stock market crashes didn’t even register on the 60/40 portfolio’s list of bear markets,” Fredlick wrote. “And the reverse is also true for bonds: While bonds stayed in a bear market for a full 40 years in the mid-20th century, 60/40 portfolios recovered from various downturns and went onto new highs.”
She continued: “But we can’t know how long it will take for the markets to recover from a crash — or where the next crash will come from. So, diversification is still the best way to navigate market uncertainty — across both the stock and bond markets — while staying invested for the long term.”
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