Analyzing Bond Performance In Stock Corrections

Source: Kevin Muir

Corporate bonds, and the indices that include them, now contain more credit risk. Another potentially negative feature of the aggregate index is that it also contains more interest rate risk than ever before.

The Bond Funds I Use

The main bond funds I use are VGIT and VTEB. VGIT invests in Treasury bonds and I use it in tax-deferred accounts. VTEB invests in investment-grade municipal bonds and I use it in taxable accounts. Neither fund contains corporate bond exposure and both funds have expense ratios less than 0.08%. I also use VTIP for TIPS exposure.

Both VGIT and VTEB own intermediate-term bonds. This means they don’t implicitly bet on rates continuing to fall like long-term bond funds. Or that they bet on rates rising like short-term bond funds. I don’t know where interest rates are going and the track record of rate forecasters shows that nobody else does either.

Summary

  • Bond Performance During Stock Corrections: Long-term Treasuries have historically been the best performers. In the 1987–1999 period when rates didn’t fall as much during corrections, bonds in general failed to provide portfolio protection.
  • Interest Rate Risk: Taking additional duration risk rewarded investors for 40 years. Historically though, bonds haven’t earned substantial inflation-adjusted returns. Bond returns during really bad S&P months are primarily rooted in their income, not price, component.
  • Correlation Between Stocks and Bonds: A reversion to a more normal (and positive) stock/bond correlation would translate to higher portfolio volatility.
  • Credit Risk: The Bloomberg Barclays U.S. Aggregate Index has only outperformed comparable Treasuries by 0.15% since 1976. BBB bonds now make up more than 50% of the U.S. corporate bond market.
  • The Funds I Use: VGIT, VTEB, and VTIP
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Disclaimer: MVMT Capital LLC (“Movement”) is a registered investment adviser located in Jackson, MS and is registered in the state of Mississippi. Movement may only transact business in ...

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