Do bonds still hedge an equity portfolio?

Thought of the day

by Chief Investment Office 26 Feb 2018

Contrary to their usual relationship, stocks and bonds are currently trading in the same direction. Both asset classes sold off in tandem during February’s stock market correction and after the release of the minutes from the Federal Reserve’s last meeting. The 13-week rolling correlation between the S&P 500 and 10-year US Treasuries remained positive at the end of last week.

Though bonds haven't fulfilled their usual role as a diversifier against falling stock prices of late, we don’t believe the longer-term negative correlation between the two asset classes has disappeared.

  • The market cycle may be entering a new phase, in which fears of higher interest rates begin to compete with, or even outweigh, hopes for greater growth. Traditional asset class relationships may be less stable in the short term.
  • This kind of change in market dynamics is not unusual at inflection points in expectations about monetary policy. In recent history, these episodes typically only last between two and 12 weeks, although during the 2013 taper tantrum the correlation was positive for a full 31 weeks, from June 2013 to January 2014.
  • Over the last decade, the 13-week correlation between the S&P 500 and US 10-year Treasuries has only been positive 16% of the time.

Over a longer-term horizon, we are confident that bonds will continue acting as diversifiers for equities, because the impact of growth across business cycles should ultimately dominate shorter-term shifts in monetary policy expectations. We still recommend remaining diversified across equities and bonds in longer-term portfolios.

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