Stock And Bond Market Correlations:

They Are Just Not As Reliable As They Used To Be

The thesis for passive portfolio management stems from a long held view that bond prices are inversely correlated to stock prices and that over longer time periods: a balanced portfolio of stocks and bonds is a safe place to keep your hard earned savings.

The basic idea was that in times of higher stock market volatility, you would get a cushion out of the "flight to quality" that pushed bond prices higher as stock prices tumbled. At the same time, in years when bond yields had a 5 handle on the coupon, you were also able to receive a nice stream of income when they were not adding the price cushion: you were paid to own them.

Times have changed.

As inflation and interest rates have fallen, so too have bond yields so you are just not getting paid the same to own them. That also doesn't give you the same kind of cushion if and when stock prices get volatile.

January 2016 was a prime example. Balanced investors got a pretty hefty scare seeing their balanced portfolios clipped by 7-10%.

A year later, the 2 year returns are looking a little better, but not back to an annualized 5% average return. 

And if over-priced equity markets take another tumble?

The bond portion of your "balance" is not going to have the same shock-absorber effect as it might have had in earlier times.

So while everybody is feeling like their portfolio is looking awfully good at the moment, there is going to be a time when this complacency becomes a problem.

As portfolio managers, our job is to be "ahead of the curve", which basically means that we are anticipating the next major move. It is why we are always calculating risk metrics, so that we know how our portfolios will react to the next big shock.

Buy and hold, passive and robo strategies do not take these things into consideration. All of their strategies are based on old-school investing techniques. Its part of the reason that ETF strategies have become so successful and are all the rave at the moment. Certainly they took investors out of the hands of the over-priced mutual fund world, but they did not take investors out of the world and risk of potential volatility.

Volatility has not gone away, it is just lurking, ready to catch investors off-guard just when they become most complacent.

Given the nature of changing correlations, this could be a rude awakening for many.

We discuss this stuff with our clients every Tuesday in our weekly client webinar , which we post in a recorded format on our website. Feel free to tune in after 5pm EDT.

There is an alternative to banks, investment dealers and robo-advisors and at High Rock we are leading the way forward with low cost, transparent and client-friendly planning and investment strategy.

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scott@highrockcapital.ca