Morningstar - Q2 2023 - 28

2018
Spotlight: Bonds
-10
EXHIBIT 1
-20
For Queen, the answer is a resounding yes. For
others, it depends on the outlook for inflation
and investors' time horizon. In the end, much relies
on the bond side of the equation.
" In the long run, whether bonds will do their
job within the 60/40 depends on what
happens to inflation on a structural level, " says
Jurrien Timmer, director of global macro at
Fidelity Investments.
To get a better understanding of what will
shape performance for 60/40 portfolios,
we spoke to experts at five of the largest mutual
fund companies: BlackRock, Capital Group,
Fidelity Investments, T. Rowe Price, and
Vanguard Group.
Here are the key takeaways:
g2022 was an extreme environment for bonds.
gThe stock/bond performance relationship
isn't set in stone. Inflation has a big impact.
gStocks and bonds move together more often
than investors might think.
gHigher bond yields should help the 60/40's
effectiveness.
gThe mix between stocks and bonds-60/40,
80/20, and so on-matters.
gDiversification still works.
" Chances of a repeat of last year's poor performance
are low, and 2023 on aggregate should be
a better year for risk assets, " says Wei Li, global
chief investment strategist at BlackRock.
At the same time, she says, " we have entered an
era of higher market volatility. And that has
implications on the 60/40 as well. "
It Wasn't Just Bad-It Was Very Bad for
60/40 Portfolios
There's no doubt about it: 2022 was a disaster
for investors relying on bonds to protect
against a significant drop in the stock market.
On the stock side of the equation, the
Morningstar US Market Index fell 19.4% in 2022
28
Morningstar Q2 2023
Bonds Lacked Ballast The Morningstar US Moderate Target Allocation Index,
a 60/40 proxy, has performed only slightly better than the U.S. stock market since
January 2022.
-40%
Morningstar US Market
-20
20
5%
-5
-10
-20
-15
-25
01/01/2022
06/01/2022
Source: Morningstar Direct, Morningstar Indexes. Data as of March 31, 2023.
11/01/2022
03/31/2023
40
2022
2021
2013
Morningstar
US Moderate Target
Allocation
-10.74
Morningstar
US Market
-13.47
0.8
for its biggest loss since 2008. Meanwhile,
the Morningstar US Core Bond Index
had the worst year in its history, down 12.9%.
Put the two together, and it was bad
news for investors. The Morningstar US Moderate
Target Allocation Index-a diversified
mix of 60% equities and 40% bonds designed
as a benchmark for a 60/40 portfolio-
fell 15.3% in 2022, just 4 percentage points
better than the stock market's decline
( EXHIBIT 1 ). Those double-digit losses made
for the 60/40 index's worst calendar year
since 2008.
0.6
0.4
0.2
-0.2
Morningstar US
Short-Term
Treasury Bond
Morningstar US
Long-Term
Treasury Bond
Why 60/40 Works ... and Doesn't Work
At the heart of diversification is the idea of
owning investments that have different
performance characteristics. If one type of asset
takes a big hit, something else in the portfolio
goes up, or at least doesn't fall as much.
Over the past 20 years, stocks and bonds
have, overall, been negatively correlated most of
the time. That's been the basis of the 60/40
diversification strategy: When stocks fall, bonds
serve as ballast.
Morningstar US
Core Bond
But when losses in the stock market are driven
by unexpected, surging inflation, Murray
says, as was the much rarer case last year, both
stocks and bonds tend to suffer. Correlations
swung up last year ( EXHIBIT 2 ).
Morningstar US
Corporate Bond
Fidelity's Timmer also emphasizes that overall
inflation can affect the correlation between
stocks and bonds.
" Looking over the past 150 years, disinflation-
that's when inflation rates are trending
lower-tends to produce a negative correlation
between stocks and bonds, " Timmer says.
" That means the 40 [bonds] side of the portfolio
becomes a port in the storm when the 60
[stocks] doesn't do well. "
" When stocks go through big, broad
selloffs, generally one of two distinct drivers
is behind the losses: economic weakness
or a spike in inflation, " says Tim Murray,
capital markets strategist at T. Rowe Price.
" When economic weakness is the driver-
and this is the most common scenario-
interest rates often go down, which is good
for fixed income. "
20-Year
2022
Q1 2023
Correlation
Cumulative Return
Morningstar US Core Bon
Morningstar - Q2 2023

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