Investors could be forgiven for feeling a little frustrated in early 2023 when they reviewed their year-end statements. Stocks, bonds, and real estate investments all produced negative returns in 2022, impacted by an aggressive rate hiking cycle implemented by central banks around the world. The sharp rise in interest rates led to painful corrections across most asset classes. At the end of the year, even well-diversified and conservative investors were left staring at losses in their portfolios. 2022 reminded us that no investment strategy, even broad diversification, works perfectly in every period.
But this year, diversification may be staging a comeback. After a fairly smooth uptrend in the first seven months of 2024, equity markets experienced sudden and significant volatility during the week of July 30 – August 5. Several market moving events unfolded in this brief window, including a Federal Reserve meeting, a weaker than expected US employment report, alarming geopolitical events in the Middle East, and an announcement that the central bank of Japan had raised their overnight lending rates for the first time in many years.
One can argue which of these events may have had the greatest impact, but in any case, equity markets swooned around the world, declining by 5-10% at their lowest points before partially recovering in the next couple of trading sessions. Against the backdrop of stock market losses, however, bond markets performed very well, generally gaining between 1% and 2% in a matter of days. The contrast between stock and bond market performance during that pivotal week is highlighted in the chart below:
As evidence-based investors, we expect drawdowns in the stock market from time to time. While the most recent drawdown certainly rattled some nerves, it was nonetheless encouraging to witness the simultaneous rally in bonds. This was in stark contrast to 2022, when sharp, sudden rises in interest rates impacted nearly all asset classes negatively.
With current yields so much higher than they’ve been in years, bonds in 2024 are starting to fill their proscribed role again as ballast in the portfolio. This means they are maintaining or increasing their value when stocks falter, helping to stabilize return volatility in diversified portfolios. In other words, bonds appear to be working again, justifying their inclusion in thoughtful portfolio design.
