Like oil and water, bonds and stocks are often at odds with each other. One goes up, while the other goes down. And that dynamic is why we use them together in a portfolio to create diversification and generate overall better risk-adjusted returns.
Or at least that’s what we think.
It turns out, the rule that most of us live by isn’t always correct, and in fact, it isn’t always true most of the time. Bonds and stocks can, and do, frequently move in the same direction. And that fact adds some serious asset allocation questions to the mix.
Bonds and Stocks Zigzagging at the Same Time
Ask anybody and the general theory is that bonds will move in the opposite direction to stocks. That is, they are negatively correlated. This idea about how they move in opposite directions is why most of us use bonds as a hedge in our portfolios. If the markets are moving lower, bonds will provide the ballast and move higher. This is the essence of diversification.
And for the most part, this has been true. Since the tech bubble burst back in 1998, correlations between stocks and bonds have been negative. They’ve provided the ballast to a portfolio.