Bond Buffer: Building Balance in Bear Markets

We often remind investors of the importance of maintaining a consistent asset allocation.

Maintaining this balance between different asset classes—such as stocks, bonds, and cash—helps manage risk, especially during times of economic uncertainty. No one can predict the market with perfect accuracy, but having a well-diversified portfolio can help soften the impact of unexpected downturns.

One important reason for a balanced portfolio is that bonds are a reliable hedge during equity market downturns. This graph (using data from NYU) is a great reminder of that fact. It shows data from 1946 to 2022 and covers some of the most challenging periods in market history, including events like the stagflation of the 1970s, the dot-com bust in 2000, and the global financial crisis of 2008. During years when the stock market faced negative returns (illustrated in blue) , we see that 10-year Treasury bonds (in green) often provided a positive return. These bonds served as a buffer, helping portfolios avoid steeper losses.

One clear example of this occurred during the 2008 global financial crisis. The S&P 500, which tracks the performance of 500 of the largest companies in the U.S., dropped by a staggering 37%. That was one of the worst declines in stock market history. At the same time, however, 10-year Treasuries surged by 20%. This massive difference highlights what is often called a “flight to quality.” When stock markets become too volatile or risky, investors tend to move their money into safer assets, such as government bonds. Treasuries, in particular, are seen as a safe haven because they are backed by the U.S. government. This trend has repeated itself over and over, from the Great Depression to today. Investors, seeking protection, flee risky assets and pour their capital into government bonds, providing a cushion during tough times.

The long-standing relationship between stocks and bonds is based on their generally opposite reactions to economic conditions. When the economy grows, stocks typically perform well because companies earn more profits. But when the economy shrinks, bonds tend to rise as investors seek stability. This is why many financial advisors recommend having a mix of both stocks and bonds in your portfolio. In good times, your stocks will likely generate strong returns, while in bad times, bonds can protect your portfolio from severe losses.

However, it is important to understand that bonds, while typically more stable, are not completely risk-free. There are rare occasions when both stocks and bonds fall at the same time. One such event occurred in 2022 when the Federal Reserve raised interest rates to combat inflation. During that time, both stocks and bonds dropped by 18%. This unusual situation occurred because rising interest rates negatively affect bond prices. While this situation was rare, it does serve as a reminder that bonds, although generally safer, can still experience periods of decline.

Despite these occasional exceptions, bonds remain a vital part of any well-rounded investment strategy. They provide consistent income and a layer of safety during periods of market turbulence. For both risk management and cash flow planning—especially for clients who regularly take distributions from their portfolios—bonds play a crucial role. Many investors, particularly retirees, rely on their portfolios for regular income, and bonds help provide that steady cash flow.

The long-term relationship between stocks and bonds is likely to continue, with bonds offering protection during times of uncertainty. This is why we believe bonds will remain an integral part of building portfolios that meet investors’ needs. A well-diversified portfolio, containing a healthy balance of stocks and bonds, helps investors weather whatever financial storms may arise.

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