Why are stocks and bonds both falling?

[RedmondStash]

I always thought that as stocks went up, bonds tended to go down, and vice versa. This year has proven me wrong.

Can someone explain why bonds & stocks generally move in opposing directions, and what's different now?

If this has already been covered in another thread, feel free to point me toward it. My Google skills may have fallen short.

[hdatontodo]

https://www.nerdwallet.com/article/investing/why-stocks-and-bonds-are-falling-together

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[maizefolk]

Short version:

Rising interest rates make existing bonds less valuable because people can buy new bonds that pay more interest on the same face value.

High interest rates decrease corporate profits (because the companies have to pay more on their own loans). Stocks decline in value both because corporate profits decrease and because when people can earn more from letting their money sit in the bank, they are less interested at putting their money at risk buying stocks.

Long version:

The story you heard about bonds and stocks reacting oppositely to recessions is true. High inflation is a different sort of shock to the system, and the USA hasn't experienced it since the late 70s when many of the parents of people on this message board were still in high school. So people didn't talk as much about, or think as much about, the risk of inflationary environments.

In the long term, stocks recover from inflation. But substantial and sustained inflation can really destroy a bond portfolio.

[vand]

Can someone explain why bonds & stocks generally move in opposing directions, and what's different now?

I suppose if you disregard the 4 decades between 1981 - 2020 where returns from stocks and bonds went up neck n neck together then it would be possible to come to that conclusion.

[TomTX]

Can someone explain why bonds & stocks generally move in opposing directions, and what's different now?

I suppose if you disregard the 4 decades between 1981 - 2020 where returns from stocks and bonds went up neck n neck together then it would be possible to come to that conclusion.

And largely via the same mechanism, applied in reverse. Bring down interest rates. Existing bonds go up in value, corporate profits soar pumping up stock prices.

[Reynold]

A lot of investment professionals look for "uncorrelated" assets, meaning their returns don't track together and ideally even move in opposite directions under various market conditions.  They are tough to find, and stocks and bonds, generally speaking, aren't it. 

[RedmondStash]

Thanks, everyone. Appreciate the insights.

[redcedar]

I think asset return correlation approaches 1 during major market shocks. When most people need it the most, diversification often breaks down and fails.

But good news is these events are rare, even if a bit clustered this decade. If we expect this sort of behavior, we can wait it out and enjoy the benefits of diversification the majority of the time. 

[vand]

I think asset return correlation approaches 1 during major market shocks. When most people need it the most, diversification often breaks down and fails.

But good news is these events are rare, even if a bit clustered this decade. If we expect this sort of behavior, we can wait it out and enjoy the benefits of diversification the majority of the time.

But if all correlations all go to 1 when you really need them not to, then they fail the acid test and the benefits of the so-called diversification are just illusionary.

I don't have a good answer btw. Maybe the price for all this financialisation and ability to invest in anything you want right at your fingertips is that correlations are higher now, and you need to sacrifice 1% in deep out of the money puts as insurance each year.

[RedmondStash]

I think asset return correlation approaches 1 during major market shocks. When most people need it the most, diversification often breaks down and fails.

Huh, that's interesting.

This downturn is teaching me a lot. Knowledge is power.

Also I get now why people love I-bonds so much.

[Arbitrage]

I think asset return correlation approaches 1 during major market shocks. When most people need it the most, diversification often breaks down and fails.

Huh, that's interesting.

This downturn is teaching me a lot. Knowledge is power.

Also I get now why people love I-bonds so much.

Nominal bonds worked great during the previous two market shocks.  Not this time around, but certainly one had to suspect that interest rates were getting too low for bonds to keep providing the same degree of protection, with a substantial vulnerability to interest rate increases.

TIPS are another great option for inflation protection, potentially better than I bonds now.  TIPS funds haven't been doing fantastic due to the spike in interest rates, but rates on new issuances (almost 2% real) are getting very attractive.

[PDXTabs]

Can someone explain why bonds & stocks generally move in opposing directions, and what's different now?

I suppose if you disregard the 4 decades between 1981 - 2020 where returns from stocks and bonds went up neck n neck together then it would be possible to come to that conclusion.

I agree. I would add that when US government bonds are bid up to nose bleed prices, the only direction they can go is down. This is what we saw in 2020.

[RedmondStash]

Can someone explain why bonds & stocks generally move in opposing directions, and what's different now?

I suppose if you disregard the 4 decades between 1981 - 2020 where returns from stocks and bonds went up neck n neck together then it would be possible to come to that conclusion.

I agree. I would add that when US government bonds are bid up to nose bleed prices, the only direction they can go is down. This is what we saw in 2020.

So -- if stocks & bonds do often track together, why are they considered the diversified foundation of a portfolio? I mean, when people talk asset allocation, they're generally talking stocks & bonds. Is it just because stocks tend to have wider swings, and bonds tend to be a little more stable?

Not disagreeing, just confused.

[PDXTabs]

Can someone explain why bonds & stocks generally move in opposing directions, and what's different now?

I suppose if you disregard the 4 decades between 1981 - 2020 where returns from stocks and bonds went up neck n neck together then it would be possible to come to that conclusion.

I agree. I would add that when US government bonds are bid up to nose bleed prices, the only direction they can go is down. This is what we saw in 2020.

So -- if stocks & bonds do often track together, why are they considered the diversified foundation of a portfolio? I mean, when people talk asset allocation, they're generally talking stocks & bonds. Is it just because stocks tend to have wider swings, and bonds tend to be a little more stable?

Not disagreeing, just confused.

I'm not an RIA and my take is worth what you paid for it.

I, personally, think that people are too quick to look at the past 100 years of the US markets and think that things will continue as they have been.  This seems like a huge error to me because the post-WW2 period in the USA will never be repeated short of WW3. Also, US government bond rates (eg, on the 10 year) had never before in history been as low as in 2020. Sometimes things change.

[YYK]

Is it just because stocks tend to have wider swings, and bonds tend to be a little more stable?

I think this is the essence of it. Bonds in a portfolio aren't necessarily useful in getting more return for less risk, the diversification ideal. They simply reduce volatility (by being relatively uncorrelated with stocks under normal conditions), which is necessary for most investors who aren't balls-to-the-wall MMM types with 100% stock portfolios. If I recall correctly from Bernstein etc., adding bonds to a stock portfolio is always going to reduce return over aggregate time periods, simply because bonds are a lower returning asset.