FIXED INCOME STRATEGY

Summer of ‘69

May 29, 2018

The persistent flattening of the U.S. yield curve has investors scratching their heads – and searching for historical parallels. We look back at the recession of 1969-70 – a downturn fueled by overheating – and its lessons for investors today.

Fixed income highlights

  • Bonds go up when stocks go down. Or so investors expect. Yet it is shocks to growth that make this relationship hold. Periodic market “tantrums” since the crisis show that when other concerns – such as inflation – dominate, this may not be the case. Stocks and bonds can both fall at the same time.
  • History shows bonds can fail to offset equity losses in periods where inflation fears rise. Today inflationary pressures are far more subdued. What will be the shock that derails the current cycle? One risk: a trade war tightening financial conditions and hitting growth. We believe bonds would cushion portfolios in such a scenario.
  • We see no imminent signs of recession, but how any recession manifests matters. Short-duration, floating rate, inflation-linked and credit exposures can help offset inflation risk. And we see long duration exposures helping cushion portfolios in a financial shock scenario that hits growth.

Snapshot

Are bonds still a good hedge to stocks? Our answer: yes, but with a caveat. The conventional wisdom that bonds prices go up when stocks go down only holds if there are shocks to growth. Bonds have historically suffered in inflation shocks, such as the 1969 example. Overall, history shows it is rare to see negative returns in both stocks and bonds in the same year. Of the 24 years with negative equity returns since 1929, U.S. 10-year Treasuries generated positive returns in all but three. See the chart Bonds hedge growth, not inflation risks.

U.S. stock vs. bond returns in years with negative stock returns, 1929-2017
Jeffrey Rosenberg
Chief Fixed Income Strategist, BlackRock Investment Institute
Jeffrey Rosenberg, Managing Director, is BlackRock's Chief Fixed Income Strategist with responsibilities in developing BlackRock's strategic and tactical views.