28 Nov 2022
With 2022 coming to end, market returns have many investors questioning one of the core diversification beliefs: the relationship between stocks and bonds.
Many diversified portfolios are built upon the historical return pattern between stocks and bonds. The diversification tenet goes that if stocks are down, bonds can be the “ballast” to offset the equity volatility. They may be down, but not as much as stocks. Investors saw this back in 2008, when U.S. stocks (S&P 500® Index) were down -37% and U.S. bonds (Morningstar U.S. Core Bond Index) were actually up 6%.
In 2022? Not so much. The aggressive moves by the Federal Reserve to try get in front of inflation by increasing the Fed Fund Rate has created historic challenges for the bond market. Recall that bond returns move inversely with interest rates – rates go up / bond prices go down and vice versa.
At the start of this year, the Fed Funds target rate was 0.0% to 0.25%. Today it stands at 3.75% to 4.0% with the expectation by many there are more rate hikes to come. What has this done to bond returns?
Through the end of October, U.S. bonds were down -16% for the year. If that sounds low, it’s because it is. While 2022 is not over, as shown in the chart below, that year-to-date return is the worst return going as far back as I could find stock and bond returns – the year 1926 during the Coolidge Administration (who can ever forget Silent Cal?).
The hard part for diversified investors has been the equally – if not more – challenging returns for equities. Through the end of October, U.S. stocks were down 18% year-to-date. In the chart below, you can see that while the stock returns are not great, investors have seen worst years for equity returns – if that helps.
But bonds? The next lowest return was back in in 1994 during the Clinton Administration when bonds were “only” down -5.4%.
Historically challenging fixed income returns
Source: Morningstar Direct. U.S. Equity: S&P 500 Index; Fixed Income: 1926-1999 = 65% Ibbotson U.S. Intermediate Government Bonds + 35% Ibbotson U.S. LT Corp Bonds, 2000-Current = Morningstar US Core Bond Index
Takeaways
- The year is not over. We have seen equity returns improve over the last couple of months. It may be a case of being “less bad” than what investors saw through the first three quarters of the year.
- In prior years when fixed income markets had negative returns, the following year saw attractive returns. No guarantee that happens again, but the yield cushion now available in the bond market is more appealing than it has been in some time.
- Frontier Asset Management strategies include more than just U.S. stocks and U.S. bonds. They have allocations to real assets, managed futures, non-U.S. stocks, high yield bonds and more. And our investment process allows us to hire what we believe are the best active managers and passive solutions available.
- No doubt 2022 will be a challenging year for many investors but return environments like 2022 have often created opportunities for disciplined investors in subsequent years. As the saying goes, it’s not trying to time the market, but time in the market that potentially rewards investors.
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| ASSET CLASS | INDEX | INDEX DESCRIPTION |
| U.S. Stocks | S&P 500 | Represents US large company stocks. |
| Fixed Income / Bonds | Morningstar US Corporate Bond | Measures the performance of fixed-rate, investment-grade USD-denominated corporate bonds with maturities greater than one year. |
| Ibbotson U.S. Intermediate Government Bonds |
An unweighted index which measures the performance of five-year maturity U.S. Treasury Bonds. |
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| Ibbotson U.S. Long-Term Corporate Bonds | A market-valued weighted index which measures the performance of long-term U.S. corporate bonds. |