Bonded for life

You’ve probably heard of the 60/40 portfolio, in which steady bonds act as a hedge for volatile stocks.

But over the past few years, rather than offsetting one another, stocks and bonds have been working in tandem to climb higher together. Now, that very interconnectedness is posing a huge risk to the bond market, according to Bank of America strategist Eleanor Xiao.

In a recent research note, Xiao pointed out that the stock market’s returns since 2021 have propelled equities to new heights. As stocks soar, their share of a 60/40 portfolio often grows out of proportion, forcing funds to automatically rebalance in order to keep their allocations steady. To do so, funds will sell stocks and use the proceeds to buy more bonds—providing a nice, consistent boost to the bond market over the last half decade.

Xiao estimates that for every $10 trillion in a diversified portfolio, investors (on average) sold $37 billion worth of stocks every month, while buying $37 billion worth of bonds. That broke down into $19 billion in treasury bonds, $9 billion in corporate bonds, and another $9 billion in mortgage bonds. This rebalancing propelled some serious demand: Roughly 14% of all new Treasury issuance and 22% of new investment-grade corporate bond issuance came from mechanical rebalancing.

This year, however, will be different. Bank of America strategists expect the stock market to grow about 4.5% in 2026, far lower than in recent years, and foresee only two rate cuts from the Fed. The combination of lower equity returns and less economic support from the central bank means fewer investors cashing out their stocks and buying bonds, removing a key piece of support for the bond market.

Back to basics

While this is bad news for bonds, a side effect could be a return to the traditional bond vs stock dynamic.

In theory, a 60/40 portfolio optimizes risk and reward, with bonds hedging stocks; in practice, since investors were gobbling up bonds at the same time they sold outperforming stocks, both stocks and bonds have been rising at the same time. If demand from rebalancing slows, we could see bonds, perhaps counterintuitively, become a better hedge and diversifier.

It looks like bonds and equities are back to being frenemies.—LB