Unlike 2022, stocks and bonds are diverging once again, just as they should. This allows investors to reap the benefits of portfolio diversification, giving bond ETFs credence if economic growth slows and the stock market recedes.
In 2022, high inflation pummeled stocks, as investors posted that higher debt service costs would eat into corporate earnings. As equities fall, bonds can typically counteract the downside as an uncorrelated asset relative to the stock market, but that wasn't the case. High inflation also pushed up yields, thereby applying downward pressure on bond prices.
Fast-forward to today and it appears bonds have returned to normalcy as a safe haven asset when equities falter. That divergence can be seen in the one-year time frame of the S&P 500 Bond Index juxtaposed with the S&P 500. The ebbs and flows in the broad market S&P have been countervailed by the bond index, acting as a shock absorber when equities trend lower. For the investor in a typical 60/40 stock/bond portfolio, this is the ideal scenario.
"The good news, as I see it, is that bonds and stocks have been moving in opposite directions," said Morningstar columnist Dan Lefkovitz. "From a diversification perspective, that’s what we call negative correlation, and it means that one asset is zigging while the other asset is zagging. And that’s what you want in your portfolio. You want assets that are going to respond to different stimuli and move in different directions."
