Bond equity correlation reversing?

Bobziz

I see the US treasury 10 year bond prices have been on a steady upward trend since last August. 4% up today. Is the correlation with equities flipping ? Today US futures seem unimpressed with the jobless figures, despite them coming in significantly lower than expected. A sign of a growing belief in a short term correction ?

bd10

The US yield curve's been steepening for quite a bit since last summer. Mind you we've been flat for about a decade. The equities/bond correlation has been changing quite a bit over the past few decades. Going forward, it'll be interesting to see how to actually play it. On the one hand, rising nominal yields are anything but helpful for a 60/40 etc portfolio as the bond side is bound to underperform. I would speculate that in periods of aggressive equities selling, Treasuries might rally in response, but bonds are stuck in their own bubble. The Fed of course is keen to keep rates expectations low, but bonds are already moving and expect another 25 bp from here to year end (just a guess). It'll be interesting to see how the dynamics will play out when tech stocks become utterly unattractive and yet bonds are in a similar situation thanks to all the asset purchases. Personally, I am careful with correlation assumptions between both.

Prism

The yield is going up, the price is going down.
Right now both equities and bonds are falling

Alexland

Prism said:

Right now both equities and bonds are falling

Global equities have been amazing with the Dow around 32,000 in recent days.

It's the exchange rate and style rotation that has been affecting some investors.

Bobziz

This is what I was referring to this morning. I wish I understood it better. My limited understanding is that one of the key risks to equity markets is rising inflation and any suggestion that the fed is considering withdrawing support. Hopefully some of the more learned forum members can explain....
https://finance.yahoo.com/news/rising-u-10-real-rate-102416217.html

Prism

Bobziz said:

This is what I was referring to this morning. I wish I understood it better. My limited understanding is that one of the key risks to equity markets is rising inflation and any suggestion that the fed is considering withdrawing support. Hopefully some of the more learned forum members can explain....
https://finance.yahoo.com/news/rising-u-10-real-rate-102416217.html

Higher inflation tends to be a sign of higher interest rates and higher longer term bond yields. That means the price of current bond funds falls as existing bonds pay a lower yield and are less valuable. Think of it this way - if you were offered a 2% fixed term savings account for the next 10 years under current conditions it might seem like a pretty good deal. However if you had a feeling that over the next few years the interest rates would rise a few percent it would make that 2% deal seem somewhat less attractive. Thats roughly what is happening. People are selling their existing bonds, which lowers the price, before everyone else wants to and before the US fed stop buying them.

Its not bad for all equities though. Cyclical sectors and especially banks like a bit of inflation and higher interest rates, which is why like Alexland pointed out the Dow has been doing ok. Growth companies like tech tend to prefer lower interest rates which is why the Nasdaq has been suffering over the last few days.

Thrugelmir

Inflation is potentially bad for growth stocks in the short term. As is effectively a tax on capital (by consuming cash). Early stage growth companies aren't generally cash generative so tap the stock market for funds by issuing new shares. Issue more shares you then dilute existing shareholders. Share price falls, then the company has to issue more shares to raise the same amount of capital. 

Nasdaq has suffered as the flood of SPACS onto the market which have raised $400 billion in the process. Aren't anywhere close to being profitable or cash generative. Taken as an average, Their individual market capitalisation's equate to 35 times current annual revenues. Pie in the Sky valuations one could say. 

Bobziz

Thanks all, really helpful. So the fact that my portfolio is overweight in growth and underweight in financials and energy in particular is something that I think I need to consider. 

JohnWinder

Yes, you perhaps ought to consider that.

I guess the choice is to hold those types of stocks in proportion to their size in the market, essentially following the market's lead which is easiest done with a tracker fund, or alternatively, be an 'active' investor and try to beat the market returns - there's seems little point being an 'active' investor and hoping to underperform the market. The thing is, all 'active' investors, as a group, can only get market returns because that's all the passive investors leave them having taken market returns themselves, and so some 'active' investors must get above market returns at the expense of some who must get below market returns. One needs to reflect on which group one is likely to be in, keeping in mind that as an individual amateur one is competing against the fund manager professionals and other wizards.

Bobziz

Thanks John. I acknowledge that my chances of beating the market are low, which is why the majority of my portfolio is in an all world tracker. At this point my active funds have enabled me to get well ahead of the market, but I appreciate that this may swing the other way soon if I don't review my selection.

JohnWinder

Oh, you walked me right into that one!

Indeed the approach you mention is one promoted by Zwecher in his book Retirement Porfolios Workbook. If your retirement savings are barely adequate he suggests putting some at risk in an attempt to boost their value, while the rest is more safely invested to create a spending 'floor' which they won't easily drop below. He talks about this approach and others based on what your 'funding ratio' is: the present value of your assets divided by the present value of your liabilities.