Unlike 2022, stocks and bonds are diverging once again, just as they should. This allows investors to reap the benefits of portfolio diversification, giving bond ETFs credence if economic growth slows and the stock market recedes.
In 2022, high inflation pummeled stocks, as investors posted that higher debt service costs would eat into corporate earnings. As equities fall, bonds can typically counteract the downside as an uncorrelated asset relative to the stock market, but that wasn’t the case. High inflation also pushed up yields, thereby applying downward pressure on bond prices.
Fast-forward to today and it appears bonds have returned to normalcy as a safe haven asset when equities falter. That divergence can be seen in the one-year time frame of the S&P 500 Bond Index juxtaposed with the S&P 500. The ebbs and flows in the broad market S&P have been countervailed by the bond index, acting as a shock absorber when equities trend lower. For the investor in a typical 60/40 stock/bond portfolio, this is the ideal scenario.
“The good news, as I see it, is that bonds and stocks have been moving in opposite directions,” said Morningstar columnist Dan Lefkovitz. “From a diversification perspective, that’s what we call negative correlation, and it means that one asset is zigging while the other asset is zagging. And that’s what you want in your portfolio. You want assets that are going to respond to different stimuli and move in different directions.”
An Active Approach to Core Bonds
As also seen in the index comparison, equities have obviously been outperforming bonds. However, if the economy starts to show signs of cooling, investors will want that shock-absorbing feature that bonds can offer.
One option is to go active, or more specifically, get exposure to the Vanguard Core Bond ETF (VCRB ). Compared to passive funds, actively managed funds allow investors to tap into the knowledge of experienced portfolio managers from the Vanguard Fixed Income Group who use their own approach to active fixed income. They can adjust holdings based on current market conditions, allowing for flexibility in volatile times as opposed to their passive counterparts.
In addition, cost-conscious investors will like the 0.10% expense ratio. In totality, VCRB invests in U.S. Treasury, mortgage-backed, and corporate securities of varying yields and maturities (short-, intermediate-, and long-term issues) for added diversification.
For more news, information, and analysis, visit the Fixed Income Channel.
