“Some men think that rules should be made of cast iron; I believe they should be made of rubber, so they can be stretched to fit any particular case and then spring back into shape again. The really important part of a rule is the exception to it.” – Paul Graham
Stocks and bonds are both in positive territory this year. This has led some to believe that something has to give. Bonds are trying to tell us something.
This is because there is a belief by some that stocks and bonds must move in opposite directions because stocks are associated with risk and bonds are associated with stability.
And it is true that bonds generally to very well when stocks fall (see Your Very Own Black Swan Strategy). But that doesn’t mean that bonds always fall when stocks rise and vice versa.
Some people have a misunderstanding of the correlation between stocks and bonds. They aren’t perfectly negatively correlated, which would mean one rises when the other falls. Stocks and bonds have close to a zero correlation historically, which means there is basically no relationship in their movements.
So they can rise together, fall together or move in opposite directions with no real pattern. In fact, on average, they have risen together more than anything:
These are the percentages of time that the annual returns from the S&P 500 and 10 year treasuries rise in the same year by decade. Nearly 60% of the time both stocks and bonds rise in the same year at the same time.
I decided to break this down a little further and see if the relationship held on a quarterly basis as well. I looked at the quarterly performance for the S&P 500 along with the Barclays Aggregate Bond Index going back to 1976 . Interestingly enough, I got the exact same number — 57% of all quarters showed positive returns for both stocks and bonds during the same quarter.
In review:
- Can stocks and bonds both rise together? Yes.
- Can stocks and bonds move in different directions? Yes.
- Do stocks and bonds have a strong negative correlation with one another? No.
- Are bonds trying to tell us something? I have no idea. Maybe? Ask me again in a couple of years.
Copyright © A Wealth of Common Sense
