BlackRock Recommends Bonds for Ballast
Richard Turnill, BlackRock's global chief investment strategist, thinks the economy is doing just fine. Nonetheless, in this week's market commentary, he reocmmends investors make a strategic allocation to government bonds.
He reminds investors that bond prices tend to go up when stock prices fall, which was the case Tuesday morning, due to escalating tensions with North Korea, which mirrored events last week. He writes:
This pattern played out again early last week when North Korea-related geopolitical concerns escalated - a timely reminder to diversify equity risk via an allocation to government bonds, in our view. This is especially true at a time when some investors have lost faith in this principle following several notable episodes in recent years when stock and bond prices moved together.
During the taper tantrum in 2013 bonds and stocks fell together, which he thinks may be preventing investors from turning to Treasuries in times of risk. But he doesn't see that scenario playing out again near-term.
Our analysis shows government bonds have provided positive returns during periods of significant equity declines, upholding their diversifying role. Of the 22 months since 2010 that featured negative U.S. equity returns, bonds notched positive returns in each month in which equities fell 2.5% or more. The one exception: during the taper tantrum. There are also periods when bonds and stocks both move up together. This has generally occurred when expectations of increased central bank support for financial markets lift both assets. Case in point after the ECB policy meeting this summer that squashed market expectations of an imminent ECB shift to normalize policy.
We do expect interest rates to rise, albeit at a very slow pace as U.S. and eurozone monetary policies gradually normalize. The implications: Expect low or negative returns for government bonds globally in the medium term. We favor stocks overall, but advocate strategic allocations to government bonds including TIPS for diversification purposes - even in the case where bonds underperform cash. We do not advocate large cash allocations, as cash dampens but does not diversify equity risk.