When stocks get volatile, many pros hedge their bets with bonds
When stocks get volatile, many pros hedge their bets with bonds
Bonds had a moment in the sun last week — they acted as quite the hedge for investors after stocks took a tumble. For those of us not on the trading floor, bonds, or debt securities, are seen by many pros as a tool to balance out a healthy investment portfolio so it’s not overly dependent on stocks, which can be more volatile.
It really is a balancing act because when stocks go up, bond prices typically go down, and vice versa. But here’s the thing. That inverse relationship, it’s not a given.
When we think about the interaction between stock and bond prices and why someone might invest in both, Paolo Pasquariello with the University of Michigan said it comes down to an old proverb: Don’t put all your eggs in one basket.
“If you put some of the eggs in stocks and some of the eggs in bonds, when one of the baskets is breaking, the other one is not,” Pasquariello said.
The inverse relationship between the two often makes bonds a good way to hedge investments in stocks. Here’s the catch, though. “It turns out that this relationship is not stable,” Pasquariello said.
Like when the Federal Reserve hiked interest rates, starting in 2022, to quell inflation, said Mark Cabana with Bank of America Securities.
“The inverse price relationship between equities and bonds no longer worked,” Cabana said. “You had a period where bonds lost a lot of their value in multiasset portfolios, simply because they were not a very good hedge due to elevated inflation.”
That’s because inflation led to higher interest rates on all forms of borrowing, and those higher rates on newly issued bonds eroded the value of older bonds paying lower rates, also known as yields.
Now that inflation has come down and interest rates are expected to ease, that bond-stock hedging relationship has shown signs of coming back. Case in point, when stock prices fell in recent trading sessions.
“Fixed income performed that … hedge function quite admirably as equity declined, fixed-income values rose pretty quickly,” Cabana said.
A period of lowering interest rates will increase bond prices, said Luis Alvarado with Wells Fargo Investment Institute.
“This is going to be very beneficial for bonds because the Fed is pivoting away from that hiking cycle,” Alvarado said.
So the eggs in the different baskets are less likely to break at the same time.
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