Won’t bonds correlate with stocks in a bear market next time round with rates at historically low levels and likely to go up?

Written by Ben Carlson (awealthofcommonsense.com)

That is a good question but before getting to my thoughts on how likely it is that both stocks and bonds crater together, let’s look at the historical track record of a 50/50 stock/bond portfolio using 5 year total returns (ensuing performance matches up with starting year):

The only time this mix of stocks and bonds went negative over 5 years was in the aftermath of the Great Depression when stocks fell more than 80% (bonds held up surprisingly well during this period). Otherwise, this simple portfolio has fared pretty well over a number of different market environments. The results have been cyclical but a split of stocks and bonds has seen positive returns over every 5 year period of the past 80 years or so.

I’ve shown the stats [below] before but it’s worth revisiting:

Here are the three times since 1928 that stocks and bonds (as defined by the S&P 500 and 10 year treasuries) both fell during the same year:

Neither got crushed in the same year (in fact, the worst annual return for bonds since 1928 was -11% in 2009). Of course, the past says nothing about the future.

I offer below a few scenarios that could see both stocks and bonds getting hit at the same time and then follow-up with a few comments on why it’s a low probability event:

I’m sure you could come up with other scenarios but the most likely one to me is sky-high inflation or a huge spike in rates.

Here’s the same graph from above on an after-inflation basis:

You can see how real returns went negative in the 1970s during a period of rising rates and high inflation. Because of the way bonds are structured (pre-set maturity dates and income schedules) their biggest threat, in the long run, is inflation.