Biggest Bond Drawdown In History Imperils Everything

Last week, I talked at some length about the purported death of the four-decade bond bull market.

We, as a community of people fascinated by, and engaged in, capital markets, write this obituary all the time. And whenever we do, it ends up being premature.

It’s always the same. Analysts read the bull’s last rites, the time of death is announced, then the financial media lowers the coffin and shovels in the dirt. Everyone says their polite goodbyes, and a few lonely deflationists linger, graveside, to bid a personal farewell to a dear friend.

No sooner have the last tearful mourners left the scene than the dirt moves. A horn pokes out. Then a hoof. It’s never long before the bull, resurrected, is back above ground, alive to fight another day. Or another decade.

Is this time different? Maybe. As detailed in “The Roarin’ 2020s And The Death Of The Bond Bull,” the current conjuncture represents the biggest challenge to the bull case in recent memory.

Between the inauguration of fiscal-monetary “partnerships” in the immediate aftermath of the pandemic (now we know it “works,” with caveats), the COVID supply chain shock (which suggested the perils of globalization go well beyond the hollowing out of middle class jobs in advanced economies), the energy crunch (which was already afoot prior to Russia’s invasion of Ukraine), the commodities crisis triggered by Putin’s war and, now, the prospect that some monetary authorities and sovereign wealth funds may shy away from developed market sovereign debt after seeing Russia’s reserves seized, some argue bond yields are a one-way ticket higher.

I’m dubious, but it’s worth noting that one widely-tracked benchmark is now mired in the worst drawdown ever. The Bloomberg Global Aggregate Index, which tracks sovereigns and corporates, is down 11% from the highs hit 14 months ago (figure below).

If you’re accustomed to thinking strictly in terms of equities, note that 11% in 14 months on a total return fixed income benchmark tracking high quality bonds is a lot. In fact, it’s more than $2.5 trillion. As Bloomberg noted Wednesday, it’s a large headache for PMs and a “particular threat” to retirees in developed markets where demographic trends mean more and more people are dependent on fixed income.

Beyond that, it underscores the notion that assumptions about a negative stock-bond correlation can no longer be taken for granted. We’ve been conditioned to believe that such assumptions are a fact of life, but that’s just not true. It’s a product of recency bias.

That negative correlation has only been reliable for around two decades. Given it’s the bedrock of almost all basic balanced portfolios (not to mention serving as the key underlying assumption for many not-so-basic strategies), its demise could be highly destabilizing.

Maybe we should be thankful for the free ride rather than bitter that it’s ending, though. For 20 years, investors enjoyed simultaneous rallies in two negatively correlated assets. We had our cake. And we ate it too. If it’s over, it was a good run.

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5 thoughts on “Biggest Bond Drawdown In History Imperils Everything

  1. “Given it’s the bedrock of almost all basic balanced portfolios (not to mention serving as the key underlying assumption for many not-so-basic strategies)”

    The 60/40 rubric is also embedded in some compliance and regulatory expectations for “prudent fiduciary” and in some performance benchmarks. For certain types of professional manager, it is likely safer to stick with some variant of 60% stocks / 40% bonds than to go off the reservation, e.g. to 75% stocks / 25% commodities-gold-crypto-private debt-whathaveyou.

      1. You have a good point here I hadn’t thought about. A big assumption in optimal portfolio theory is that the risk-free interest rate is relatively stable.

        A rapidly increasing interest rate will force optimal portfolios to de-allocate from assets in large chunks every rebalancing period.

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