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Global Allocation Insight

Why we treasure our bonds

February 21, 2020

In today’s market environment, Treasury bonds play a key role.

With the U.S. stock market touching record highs of late, investors may start looking for ways to protect their portfolio amid macro concerns — the still-unquantifiable risk of a spreading coronavirus, lingering geopolitical tensions in the Middle East, and the potential for controversy over the U.S. Democratic presidential primaries. In this environment, long-term U.S. Treasury bonds can be an effective hedge against stock market risk.

Should stocks continue to rally, investors are likely to lose a bit on bonds as more stable economic prospects put upward pressure on interest rates. (Bond prices fall when interest rates rise.) However, we believe that any rise in interest rates is likely to be constrained by the modesty of this economic expansion and the lack of any pickup in inflation.

The returns on stocks and U.S. Treasury bonds have been negatively correlated more often than not over the past decade. Despite the historically low level of bond yields today, stock-bond correlations remain solidly negative. In other words, bond prices still tend to rise, and yields fall, when stock prices drop. This dynamic becomes even more compelling when you look at the relationship between stock/bond returns and volatility. 

Looking back on the post-crisis period, when volatility increased, the 10-year Treasury bond typically beat the stock market by roughly 1.5%. When volatility dropped, stocks won by a similar amount. This negative correlation more than doubled when volatility spiked, making Treasury bonds a favored hedge when uncertainty rises.

Treasury bonds can hedge stock market risk
Correlation of bond and stock market returns

Correlation of bond and stock market returns

 

Source: Refinitiv Datastream. Chart by BlackRock Investment Institute. Rolling 90-day correlation of daily returns on U.S. 10-year Treasury bond and S&P 500 Index, 1/1/1985-1/28/2020.

We expect a combination of ample liquidity, a strong labor market and a solid housing market will continue to sustain the U.S. economy and provide support for stocks in early 2020. However, given current macro risks, we think it’s wise to be prepared for episodes of heightened stock market volatility.

The BlackRock Global Allocation Fund holds a significant position in U.S. Treasuries, albeit a bit less than its reference benchmark. We actively manage yield curve positioning within the fund’s Treasury allocation and, while still underweight relative to the reference benchmark, we recently shifted in favor of the long end to increase duration (interest rate risk).

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Russ Koesterich, CFA, JD
Russ Koesterich, CFA, JD, Managing Director and portfolio manager, is a member of the Global Allocation team.   Mr. Koesterich's service with the firm dates back to 2005, ...

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