The Bond Market Is Repeating a Pattern Not Seen in Years. Here's What History Says Comes Next.

Much to the chagrin of the investors who were around at the time, the bond market is once again at 2007 yields, and if history is any guide, whatever comes next will be determined by whether the economy powers ahead or stumbles.

On Sept. 30, the 10-year Treasury yielded 5.26%, and on June 12, 2007, it closed at the same point. Owners of the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT), an exchange-traded fund (ETF) of long-dated government bonds, are getting particularly stung here, since bond prices fall mechanically when yields rise; its total return is down by 7.5% this year so far, and more pain may be ahead.

The last time this dynamic occurred, the high and rising yields preceded a nasty crash in the stock market, though rising bond prices ultimately rescued many well-diversified investors afterward. The trouble is, this time the prospect of relief with bonds is nowhere to be seen, and neither is any crash in stocks.

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In 2008, 10-year Treasuries gained 20%, and stocks fell 37%

In 2007, the catastrophe unfolded slowly at first.

Amid a weakening economy and a strained consumer, the S&P 500 (SNPINDEX: ^GSPC) continued to rise for roughly four months after the 10-year Treasury yield rose beyond 5%, peaking on Oct. 9 of that year. After that, a 17-month stock market tumble ensued, and investors fleeing into government debt drove yields well below 5% amid their demand. That year, 10-year Treasuries returned 20%, while the S&P 500 declined 37%.

But 2026 is already looking quite different from those conditions.

From November 2000 through 2020, the correlation between stocks and bonds was negative (meaning they moved in opposite directions), or at times barely above zero. From 2022 through 2024, that correlation was fairly strongly positive, at 0.5. For an example of what this looks like in practice, consider Sept. 23, when stocks and bonds fell together in lockstep amid ongoing concerns about rising inflation stemming from elevated oil prices.

So what does this mean?

What should investors be doing with bonds right now?

According to historical data, during a growth scare, bond yields tend to fall, and long-dated bonds rally (again, bond prices typically rise when yields decline). If inflation is the concern, both stocks and bonds can slide together, as in 2022, when the S&P 500 lost 18%, and 10-year Treasuries declined by 18%.

Neither scenario makes bonds useless. As yields rise, the case for holding fixed income in a diversified portfolio grows more compelling, even though bonds' correlation to stocks has frequently been positive in recent years. Furthermore, Fortune calculates that the equity risk premium, that is, stocks' expected outperformance over inflation-protected Treasuries, was just below 1% as of Sept. 26, a level reached in the past two decades only during the 2008 financial crisis and in the depths of the COVID market crash.

So, history says that you're definitely not going to get rich by buying bonds right now, especially if the Federal Reserve keeps hiking interest rates. It also says that buying them right now is not a foolhardy move. And even if holding bonds means missing out on some growth, the current set of conditions could still make bonds a great hedge against downside risk in the stock market, but only if the next scare is about slowing growth rather than inflation.

Therefore, if you want to buy bonds, treat them as a growth-scare hedge, and keep them small enough in your portfolio that you can stomach further (likely temporary) losses if need be.

Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.