Analyzing Bond Performance In Stock Corrections

Source: Allocate Smartly

The other extreme potential scenario would be if U.S. interest rates continued to drop, like they did in Japan. The 10-year Japanese government bond yield hasn’t been higher than 2.0% since 1999. There is some evidence for this possibility. U.S. interest rates are tied to inflation, inflation is tied to demographics, and U.S. demographics are not inflationary.

The graph below shows the relationship between U.S. births as a percentage of the total population (the blue line) and future U.S. annual inflation (the red line). The blue line is advanced thirty years into the future. That said, demographics are just one driver of long-term interest rates.

Source: Raoul Pal

The table below shows 10-year U.S. Treasury bond performance during months where the S&P 500 declined more than 5%. The researchers wanted to find out where bond returns in these negative months came from — bond coupons or bond prices rising?

The column to the right, “Bad Months”, breaks down bond returns into capital appreciation (Cap App TR row) and income (Inc ER row). Bond returns during bad S&P months stem from the income, not price, component.

Source: Alpha Architect

U.S. Treasury bonds of all maturities currently yield less than 3%. This means there will be less of a bond income buffer during the next stock correction.

Correlation

Negative correlation between stocks and bonds has supercharged the diversification benefit of bonds.

The long-term average correlation between stocks and bonds has been positive 0.20. A low positive correlation means stocks and bonds have diversified each other, but not in a huge way. This dynamic changed two decades ago when bonds started exhibiting a negative correlation to stocks. PIMCO wrote about one potential reason for this shift.

Source: GMO

Combining two negatively correlated assets significantly reduces a portfolio’s volatility. One asset zigs when the other zags, dampening portfolio risk.

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Disclaimer: MVMT Capital LLC (“Movement”) is a registered investment adviser located in Jackson, MS and is registered in the state of Mississippi. Movement may only transact business in ...

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