Stock & Bond Correlations

If you are actively managing your portfolio, you might not even notice the correlation between the overall stock and bond markets. However, you might notice which of your stocks are long and short durations plays. This annoys a lot of fundamental investors because they don’t look at their portfolios through that lens. They try to buy good businesses that will grow their free cash flow and eventually return it to shareholders. That’s a fine ambition, but you might want to alter your portfolio if you find that all your stocks are of one variety.

Even though you’re looking at the fundamentals, you have a new risk if all your stocks are long-duration plays. You don’t need to sell because of this. Use this as a clue that some of your stocks might be fully valued. Valuation is certainly part of the lexicon of fundamental investors while macro largely isn’t.

If you are in a passive fund with stock and bond allocations, you probably noticed that in the past couple of months, stocks have been highly correlated with bonds. This is shown in the chart below.

From the outside looking in, this doesn’t sound terrible because the stock market isn’t down much. Why would anyone care if the S&P 500 has fallen 3%? People care because bonds are supposed to be a cushion for equity investors. Investors who have 60% of their portfolio in stocks and 40% in bonds expect to lose less than the S&P 500 when stocks fall. When they don’t lose less, they wonder why they are in bonds. In this case, they are earning less over time and still feel the brunt of day-to-day volatility.

We are sure some people are looking at this chart and wondering why anyone with bonds cares if the correlation has been positive for a couple of months. It looks like the positive correlation spikes are only temporary. Passive investors are worried because there is a widespread belief that yields can’t fall much further. Since the 10-year yield is at 1.58%, investors wonder if bonds can continue to rally when stocks fall. If you own bonds but don’t think they will provide good returns over time, you must alter your portfolio instead of getting frustrated with the results!

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Disclaimer: The content in this article is for general informational and entertainment purposes only and should not be construed as financial advice. You agree that any decision you make will be ...

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