I doubt that’s how you reacted when reviewing the 2021 performance scoreboards, of course. The total U.S. domestic bond market lost 1.9% last year, as judged by the Vanguard Total Bond Market ETF BND, -0.08%. Long-term Treasurys lost even more, losing 5.0% . You might think it’s difficult to put lipstick on this pig.
Those who nevertheless were disappointed by bonds’ performance last year want to have their cake and eat it to. But that’s magical thinking: Given that the stock market performed so spectacularly last year—up 25.7%, as judged by the Vanguard Total Stock Market ETF VTI, -0.17% —it therefore should not come as a big surprise that bonds struggled.
In light of what happened last year, it now appears that the positive stock-bond correlation in early 2020 was a temporary phenomenon. This is illustrated in the accompanying chart, which plots the trailing six months’ correlation between the total stock and total bond markets. Notice that, though this correlation shot way up to very high levels early in 2020, it since then has declined back to prior levels.
The study, which I first wrote about last May, urges us to focus instead on how far interest rates could fall in any given 12-month period. Only if you think rates can’t fall very much—50 basis points or less—should you question bonds’ potential to be a good diversifier. So long as you believe it possible that rates could fall by at least 100 basis points, then bonds retain close to their full diversification potential.
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