Correlation Between Stock and Bond Prices

[Soes Bandit]

Hi All,

I wonder if there is anyone on this forum who may be able to shed some light on the above?

I have read that these move in the opposite direction. The reason being that they compete with each other for investment capital. As the economy is expanding and stocks are doing well, people move over to stocks. When the economy slows down and growth is stocks is less promising, people move over to bonds for a fixed return.

This makes sense, but what about when interest rates are changed? If interest rates are lowered, typically this is bullish for the stock market and this will also increase the value of the bond market and so they move together. If interest rates are tightened, this is bearish for stocks and will also lower the value of the bond market.

Isn’t this a contradiction to the age old believe that the instruments are negatively correlated?

Also, what do you suggest for a trader wanting to keep an eye on the overall US Bond market? ZB (30 year treasury bond futures) TLT (20+ year treasury bond ETF), AGG (iShares Barclays Capital Aggregate Bond Index ETF) or LQD (iBoxx $ Liquid Investment Grade Bond Index ETF)?

I hope someone can answer. This caused me a sleepless night worrying about it!

Thank you

 

[Rhody Trader]

The relationship between stock and bond prices moves in cycles. As you've noted, they are often negatively correlated because of investment flows back and forth. There can be times, however, that they move together. This tends to be in more transitional periods in the economy.

 

[gerryg]

The relationship between stock and bond prices moves in cycles. As you've noted, they are often negatively correlated because of investment flows back and forth. There can be times, however, that they move together. This tends to be in more transitional periods in the economy.

maybe it means they have no correlation at all? Or maybe only change of overall preferences during risk-off/risk-on trading, i.e. moving from equity to fixed income market?

 

[Soes Bandit]

From my research I believe that generally they are negatively correlated. There can also be times when they both go up or down. I.e. too much investment cash in the system, or fear in which neither equities or bonds are trusted. I believe when John says transitional periods in the economy, this is what he is talking about.

You’ve got to keep in mind that bonds market dwarf the stock market. Any time there is risk in the markets traders jump into the bond markets because the bonds can be used as a hedge. Markets sell off and bonds rally.