The Shifting Role of Bonds

Our latest research on the stock-bond correlation projects that bonds will be a valuable diversifier over the next five years. But at what price? The Capital Asset Pricing Model (CAPM) is surprisingly effective at explaining expected return variation in stocks and bonds. From a fair value pricing perspective, current bond yields are not unreasonable if stocks become relatively more volatile and bonds offer strong diversification. Still, one may worry that low yields limit the upside potential of bonds. We argue that current low bond premiums do have precedent, and bonds may still offer helpful diversification to stocks in the future.