Emerging-market bonds, and particularly those issued in local currencies (e.g., denominated in Brazilian real instead of U.S. dollar) have had stellar returns in 2009. I ran a few calculations in Morningstar EnCorr and quickly found out that these bonds have a reasonable diversification power, particularly if you are bullish on the market's credit risk appetite and bearish on the dollar.  

However, I bet you would not have expected that emerging-market bonds have moved a lot in sync with U.S. high-yield bonds:

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There has been a great deal of discussion, on our blog and more broadly, on the question of which direction the economy, and in turn the markets, will take in the months to come. I seek to highlight a forceful voice of caution here--that of Jeffrey Gundlach, chief investment officer of TCW. Gundlach argues convincingly that we're not out of the woods yet. Indeed, he says, trouble could come sooner rather than later for risk assets. (See also my conversation with Gundlach and Bob Rodriguez earlier this year for Morningstar Advisor magazine.)

In a recent meeting here at Morningstar, he told me that the debt binge that brought the United States to the financial crisis was not created overnight. In fact, he isolated a number of stages to the debt explosion, which began in the early 1980s and by the first quarter of 2009 had left total credit market debt at roughly 375% of gross domestic product, its highest level on record.   More 

As everyone now knows as a result of late-2008's financial crisis, return correlations between most asset classes, originally thought to behave differently one from another, can converge during times of extreme market stress. One fascinating manner of thinking about this problem is discussed in a PIMCO market commentary by Vineer Bhansali.

Bhansali argues that we must progress from thinking about investment diversification in term of asset classes to thinking about risk factors and accounting for them independently of how they're embedded in the range of asset classes available to investors. In other words, although people expect the fixed-income portion of their portfolio to bolster returns as the equity side collapses, this view ignores the fact that many bond sectors themselves hold an equity risk factor.   More 

The wagers on prediction markets such as Intrade astutely suggested several weeks ago that Fed Chairman Ben Bernanke would get a second term. Now that it looks like he will, we can turn our attention to a more economically fundamental prediction market to get an indication of what Bernanke has in mind on rates policy. The Fed has indicated it will maintain its target low for the Fed Funds rate, but some have speculated that economic stimulus measures, when combined with the so-called "green shoots" of early signs of economic recovery, might force the Fed's hand toward a sooner-than-expected rate hike.   More 

With equity markets recently hitting new highs for the year, and a tremendous rally in virtually all risk asset sectors of the fixed-income markets, we've long arrived at a market consensus that the "Armageddon scenario" is off the table. But one still has to ask the question: Has the market come too far, too fast? I put this question to leading asset-allocation guru Rob Arnott, founder and chairman of Research Affiliates, and his outlook is instructive.   More