Investors have had an unpleasant 2022, to put it mildly. Both stocks and bonds have dropped by more than 10%. On top of that, inflation rates at around 8.5% are the highest in four decades, reducing the purchasing power of whatever remains investors’ portfolios and promising big increases in interest rates by the Federal Reserve that threaten future investment returns.
The losses in the bond market are particularly insidious because fixed-income assets are supposed to protect portfolios due to their lower volatility and low or negative correlation to equities. However, history suggests this would be a bad time to reduce bond allocations. To see why, take a close look at the investment characteristics of bonds and stocks. Although long-term correlations between stocks and bonds are near zero, there are periods of high positive and high negative correlation. Over an entire market cycle, from stock market peak to new peak with a drop of at least 10% in between, bond investors generally suffer along with equity investors.