For this week’s chart, we look at the correlations of different bond sectors. Often when we talk about bonds, we lump them altogether. However, just like stocks have different industries, sectors, styles, etc., there are many different types of bonds.
We are focusing on the segments of bonds included in the Bloomberg Barclay’s U.S. Aggregate Bond Index, probably the most widely followed bond benchmark. This index includes U.S. Treasury Bonds, U.S. Government Agency Bonds, mortgage-backed bonds, asset-backed bonds, and investment grade corporate bonds. Riskier bonds such as high-yield (junk) bonds and emerging market debt are not included.
These different bonds have different drivers that determine their cash flows, so it is useful to observe how they perform relative to each other. To do this, we focus on the top clip of the above chart. The blue line represents the median (average) correlation of each of these different bond sectors to the index as a whole.
Note that much of the time, this blue line moves along pretty close to 1 (at the top of the chart). This means that all of the different areas of the bond market are moving in similar directions. During these times, bond performance is generally being driven by broad movements in interest rates.
However, we see that during times of market stress (the late 1990’s through early 2000’s, the 2008 financial crisis, and the recent 2020 pandemic crisis) correlations fall as investors evaluate how each segment of the bond market will react to the increased risk.
The most recent crisis has pushed bond correlations to all time lows, showing that the recent crisis has resulted is substantially different performance amongst bond sectors. This can be masked if investors only look at the performance of the broad index.
Another important thing to note on the above chart is that after the initial decline in correlations, the lower level of correlations tends to persist for some time. Previous crisis have resulted in lower correlations for years afterwards. This suggests that over the next few years, the types of bonds owned by investors could be more important that they have been in the previous few years.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.