Investors just endured their second correction in U.S. stocks this year, and bonds proved once again that diversification plays a vital role in managing risk during market turbulence.
The 10-year Treasury yield dropped 20 basis points over nine straight trading sessions from November 9 to November 23, while the S&P 500 Index fell 10.2%. As shown in LPL’s Chart of the Day, diversified fixed income portfolios, represented by the Bloomberg Barclays Aggregate Bond Index were flat during that two-week stretch.
Since 2008, bonds have outperformed stocks in all 14 S&P 500 corrections by an average of 14.4%. A hypothetical portfolio with 60% in S&P 500 stocks and 40% in a diversified portfolio of bonds would have outperformed an all-equity portfolio by 5.8% in those corrections.
“S&P 500 pullbacks generally arrive without warning,” said LPL Chief Investment Strategist John Lynch. “Investors need to be prepared for such events, and high-quality bonds may help manage risk for diversified long-term portfolios.”
It may be tough to justify owning bonds in the current market environment, especially as the Federal Reserve eyes at least three rate hikes between now and the end of 2019. However, even in rising-rate environments, bonds have historically provided a hedge to stock market volatility, in addition to interest income and liquidity.
Diversified portfolios may be especially important in the upcoming year. We expect more stock market volatility as economic growth moderates, rates continue to climb, and financial conditions tighten. Given our expectation for gradually higher interest rates, we recommend suitable investors generally move closer to the benchmark Bloomberg Barclays Aggregate Bond Index but continue to position portfolios with below-benchmark interest rate sensitivity and above-benchmark credit risk.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted.
The hypothetical example presented is not representative of any specific situation. Your results will vary. The hypothetical rates of return used do not reflect the deduction of fees and charges inherent to investing.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Bonds are subject to market and interest risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
This research material has been prepared by LPL Financial LLC.
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