As interest rates shot up in early 2022 and continued to increase through most of 2023, bonds’ long-standing pattern of diversifying stock exposure was turned on its head. While most bond types fell less than stocks in 2022, their returns were directionally similar: down. That has heightened bonds’ correlation with stocks, according to Morningstar’s recently released Diversification Landscape report from Amy Arnott, Karen Zaya, and me.
But over the long arc of market history, high-quality bonds have shown an ability to diversify stock exposure. Not only are many equity market shocks characterized by a flight to safety in which Treasury bonds thrive, but in weakening economic conditions, interest rates are often simultaneously declining, boosting bond prices. Lower-quality bonds, meanwhile, have shown much more of a connection to stock-price movements and therefore should be considered third-tier diversifiers for investors’…
