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Bonds Were a Safety Net When Stocks Fell, Investors Fret They Aren't Anymore


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A reliable link between stocks and government bonds that defined a popular investment strategy for decades has broken this year. Some investors worry the rupture is permanent.

Investors for years could chase returns and guard against economic ups and downs by putting 60% of their funds in stocks and 40% in bonds. When storm clouds gathered and the S&P 500 took a hit, Treasury yields would typically fall and bond values rise, alleviating losses on stocks.

But the wave of central bank stimulus unleashed to combat the Covid-19 crisis has repressed government bond yields in the U.S. and elsewhere, and threatens to keep yields trapped at low levels for years to come. Even as stock markets have recovered since April, 10-year Treasury yields have barely budged.

The fear is that when stocks next take a tumble, bonds won’t cushion the fall. Investors have been left hunting for another simple way to balance risks.

It is rare for stocks and government bonds both to fall in value together, but that happened in March: A basic 60% stocks-40% Treasurys portfolio suffered one of the worst single-month losses since the 1960s, according to Goldman Sachs. The only worse returns occurred in 2009 and 1987.

March’s falling bond values “added insult to injury instead of helping to balance a multiasset portfolio,” said Stéphane Monier, chief investment officer at Lombard Odier in Switzerland. “This experience could repeat itself more often in future because we have reached an effective lower bound for government bond yields.”

To be sure, strategists have called the bottom in bond yields before, only to see fresh crises provoke new central bank actions that took yields down another notch. But this summer, 10-year Treasury yields didn’t rise as the economic outlook improved and stocks rebounded.

One reason is that the Federal Reserve has signaled that interest rates aren’t going up or down for a long time, locking yields in a tight range. Chairman Jerome Powell said in May the Fed didn’t want to take rates negative, and confirmed in August that it wouldn’t raise rates until inflation had run above target for a time.

The effects of this stance can be seen in the different reactions of Treasury inflation-protected securities, or TIPS, and ordinary Treasurys. While 10-year Treasury yields haven’t moved much up or down this summer, the yields on TIPS, known as real yields, fell steeply from early June to late August as investors’ expectations of higher inflation grew.

The 60-40 rule for a balanced portfolio has long been the starting point for many U.S. investors, according to Goldman Sachs. Since the 2008 crisis, money has flooded into multiasset funds in the U.S., more than doubling their total assets to about $4 trillion, said Christian Mueller-Glissmann, multiasset strategist at the firm.

“The 60-40 portfolio works best when there is good economic growth and low inflation,” said Mr. Mueller-Glissmann. “In the future, there is less likely to be such a favorable mix.”

The risks of much higher inflation and alternatively, of deflation, are both greater than in the past, he said. This is partly why the classic balanced portfolio is unlikely to function well for a long time, so investors need different solutions.

Mr. Monier of Lombard Odier has been looking for income in markets like Chinese government debt, where 5-year bonds pay about 3% versus the less than 0.3% available on 5-year Treasurys.

He also favors gold as a store of value. In a world where many bonds’ real yields are negative, the fact that you have to pay to store gold doesn’t matter like it used to, Mr. Monier said.

Sébastien Galy, senior macro strategist at Nordea asset management, isn’t looking at gold because it offers no cash flow, is difficult to objectively value and behaves inconsistently during market selloffs.

“We look at currencies instead for diversification: the U.S. dollar or the Japanese yen versus more cyclical commodity-currencies like the Australian dollar,” he said.

The advantage of currencies, Mr. Galy said, is that you can always value and trade them.  He believes the yen and dollar still behave like havens when investors fret about other assets.

Alberto Gallo, head of macro strategies at fund manager Algebris, prefers investing in convertible bonds and holding more cash. Convertibles do well when stock markets rally because owners can make bigger profits when the bonds convert into shares. But if shares fall, convertible owners still get paid their coupons.

Cash is good for taking advantage of downturns. “If you have cash you can use moments of panic to either buy good bonds cheaply, or to sell protection against ‘tail risk’ [the risk of sudden big falls in asset values],” Mr. Gallo said.

Write to Paul J. Davies at paul.davies@wsj.com

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