Sunday Chart Check: “Doesn’t This Equal Panic?!”

I’ve talked almost incessantly about the reversal of stock/bond return correlations over the past several weeks.

I won’t rehash it all here, but what’s important to understand is that since the late 90s, stock/bond return correlations have been largely negative. In an environment of rising bond yields, you generally want that trend to continue. Why? Well, because if you’re taking capital losses on the bond side of your portfolio, the hope is that outperformance on the equities side will act as a buffer. Thankfully, stocks have risen since the election in November, giving investors some measure of relief from the sharp repricing of yields (i.e. stocks have mitigated the bond selloff).

That said, we saw evidence in 2016 that the correlation between equity and bond returns can turn positive. The danger in 2017 is that we get what some on the sellside call “reflation frustration,” wherein bond yields continue to rise but investors’ expectations for growth aren’t ebullient enough to buoy stocks. In that case, the correlation between the two assets turns positive, leaving few options for those seeking diversification.

Needless to say, if there’s “nowhere to run” (so to speak), you’d expect vol. to spike as investors and money managers alike panic. Well, in yet another example of how traditional relationships have broken down over the past five or so years, we’re seeing evidence that the market isn’t thinking about rising cross-asset correlations the way it used to. Consider the following chart from Citi’s Matt King:

Correlation.png

“But doesn’t correlation equal panic?,” Citi asks.

Apparently not. Or at least not for now.

But how long before this mean reverts? And more importantly, when it does, will correlations fall or will vol. rise?

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5 thoughts on “Sunday Chart Check: “Doesn’t This Equal Panic?!”

  1. I can’t help but wonder how the ubiquity of big data and increased computer power may have shifted how the world works. I work in retail and clearly the world has changed over just the last two years. I wonder how the world of finance has changed since 2009? Increased regulation, big data, Fintech, better algorithms, M&A, etc. have all had a fundamental impact. Business cycles have been traditionally pushed by bad or out of date information about sales and inventory levels, but that data is now real-time.

    I think that if we continue to view the markets and economy through the lenses of the past, we’ll miss what is right in front of us. One term that is still relevant from the past is “Irrational Exuberance”. That one will never go out of style.

    I am all in cash, FWIW.

    • While there is a growing amount of real time data, there is still a lot of data that takes extraordinary amounts of time to become available to the public. I’m primarily referring gov. economic data. As well, public corporations still report quarterly and that is far from real time. Of course there is a lot of data whose collectors actually benefit from purposeful delays – even though the technology exists for real time – generally involving billing where a company enjoys the float acquired in the delay.

      • I was more referring to the availability of data to the actors who actually impact the macroeconomic trends reported by the government and corporations. It is the inventory planner at the warehouse who has real time data on what is selling and what is not by store with 10 minutes of delay. It is the logistics planner who can see what shipments are where and when things will actually arrive. It is all the financial analysts who can trade currencies in real time around the world to reduce delays and arbitrage inefficiencies in 24 time zones.

        The government just reports what has happened as a result of these actions as do corporations in their 10K’s.

  2. Thank you for being a broken record on this and please keep it up. Equity-bond correlation is a threat to the trusting individual households following conventional investment advice to hold a “prudent” “portfolio” of stocks and bonds.

  3. Cash is not bad.
    It simply is an option to the volitility and the correlation (non) that we see and deal with.
    With the chief tweeter moving markets
    preservation is high on the list for us that need to survive
    Markets ruin billionaires too

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