On Simultaneous Surges.

There’s been no shortage of commentary about Q1 being a “Goldilocks” quarter for assets of all stripes.

Obviously, risk assets were buoyant as the Fed’s dovish pivot and the follow-the-leader dynamic it precipitated among the FOMC’s global counterparts slammed the brakes on the Q4 malaise, presenting market participants with a familiar quandary: Does it make sense to fight the benefactors armed with printing presses?

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But in the context of the post-crisis world, this time is “different” in that policymakers are confronting what looks like a synchronous downturn with little in the way of “ammo”, as policy rates are at “best” just barely off the lower bound (at “worst” still mired in NIRP) and balance sheets are still bloated. Additionally, the current global slowdown arguably (and anecdotally) has a more “endemic” feel to it than what we saw in 2016.

Eventually, one assumes a “policy impotence” trade will get some momentum, but in the meantime, risk assets have rallied even in the face of plunging DM bond yields, with the latter development seemingly “saying” something rather disconcerting about the outlook for growth.

One thing that obviously helps is the benign combination of falling real yields and rising breakevens (think: massive rally in crude off the lows). That, as opposed to the rather pernicious situation that vexed markets late last year, when real yields were stubborn while the reflation story died on the proverbial vine alongside crude’s dramatic plunge.

Globally, equities jumped nearly 13% (total return) in the first quarter, while global 10+ year bonds delivered to the tune of 3.7%, for the best combined bond + equity performance since the third quarter of 2010.

Anyway, one thing worth noting as you ponder all of this is that while the scope/ferocity of the plunge in government bond yields should give equity investors pause, the fact that bonds and stocks rallied together in Q1 isn’t strange.

“Given the slump in bond yields and general decline in economic growth expectations, it is perhaps surprising that equity markets have been so strong [but] quarterly periods in which global bond and equity markets both rally are quite common; 44% of quarters fit the description since 1988”, SocGen’s Andrew Lapthorne writes on Monday, adding that since 2000, 34% of quarters have seen a simultaneous rally in stocks and bonds.

(SocGen)

Note that the latter point (about the post-2000 numbers) underscores the beauty of the negative stock-bond return correlation witnessed over the past two decades. The bond/equity correlation has generally been negative over that period, so investors enjoyed both the diversification that goes along with the negative correlation and a longer-term concurrent rally evidenced by, for instance, more than three quarters of quarterly periods witnessing gains for both asset classes. It’s been a “have your cake and eat it too” type of deal, and some of the worst episodes of turmoil in 2018 occurred when the bond/equity correlation flipped positive amid rising yields (e.g., early October and just prior to the February 2018 VIX explosion).

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By contrast to the common phenomenon when both stocks and bonds rally, periods during which both lose money are relatively rare. That occurs around 10% of the time, the above-mentioned Andrew Lapthorne writes, in the same note, before lamenting that  “sadly, this tends to be the case during the worst quarters for equities, i.e., diversification fails when you most need it.”