Date
21 January 2017
In the era of zero or negative interest rates, it's becoming questionable if stock investors can get some sort of downside protection by diversifying into bonds. Photo: Disequilibrium.org
In the era of zero or negative interest rates, it's becoming questionable if stock investors can get some sort of downside protection by diversifying into bonds. Photo: Disequilibrium.org

Rethinking the relationship between bonds and stocks

A common goal for stock investors who invest in bonds as well is to reduce the overall risk profile, given the usual negative correlation between the two.

When stock markets weaken, the bond portion of a balanced portfolio offers some sort of cushion because the two typically do not move in the same direction.

It’s true that statistically, bonds and stocks hardly move in lock step, but a closer look at the way statistics are used to measure their relationship reveals that they move in tandem more often than thought, albeit with a time lag.

Over the past 80 years, there were only eight occasions when bonds and stocks went up or down together for two consecutive months.

It sounded really rare but there were many more cases of bonds falling a month or two after stocks declined.

In that sense, the odds for these two markets to move in the same direction loosely are actually much higher than thought.

For investors who still want to use bonds to balance their stock exposure, it is important to bear this in mind.

Additionally, in the current negative interest rate era, it is becoming questionable if bonds can really provide the protection needed when stock markets tank, as they themselves are already so expensive.

One more thing, like any kind of correlation between a pair of assets, be it oil price and stocks, US dollar and gold, as well as bonds and stocks, the relationship changes over time.

In some cases, the relationship can change suddenly.

The full article appeared in the Hong Kong Economic Journal on Aug. 15.

Translation by Raymond Tsoi with additional reporting

[Chinese version 中文版]

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CG

Columnist at the Hong Kong Economic Journal

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