One of my favorite pastimes is debunking the notion that stock prices and bonds yields ‘always’ correlate. Years of indoctrination from the conventional wisdom of money managers have done us no favors as market watchers. Even if you don’t invest or actively make decisions about your 401k allocation, you’re still likely familiar with the notion of moving out of stocks/bonds and into the other.
The net effect of such asset allocation strategy is simple. If you’re selling stocks to buy bonds, then charted lines of stock prices and bond yields would move lower together (because buying bonds = higher prices and lower yields). This line of thinking makes the following stock/bond movement in early September very logical.
Indeed, looking at the chart above, it’s easy to conclude that the conventional wisdom is right and that what I’m about to tell you is wrong. But let’s zoom that chart out a bit.
Striking, no? As usual, the truth is somewhere in the middle. We do indeed see strong correlation at times–usually over short time horizons (but even over longer time horizons in 1999-2009). But the more we zoom out, the more that correlation breaks down. The modified approach is to lean on the short term correlation when it’s clearly setting the tone. Additionally, we also have to consider that the correlation won’t necessarily look perfect, even if one side of the market is definitely influencing the other.
While it’s harder to see with the naked eye, one of the best examples we have of this modified analytical approach is that of a burgeoning stock sell off making a case for bonds to abandon a gradually weaker trend. The second half of last week is the most recent example.
If we zoom out to a wider frame of reference, the correlation is harder to see, but the scope of weakness in stocks becomes more clear. This is now the biggest sell-off for stocks since the post-covid recovery began. Bonds certainly aren’t eager to follow suit, but they are nonetheless forced to absorb at least some of the dollars fleeing the stock market.
If this is enough to prevent yields from breaking their current ceilings (0.73 and .79, most immediately), so be it. That said, it would probably take a fairly massive stock sell-off to help bond yields get through their bigger picture floors at .63, .57, and 0.50. On the other side of the coin, we also have to wonder how much of a recovery in stocks would be needed in order for bonds to get back to their previous business of pushing toward higher yields. With a fairly light economic calendar, that’s actually one of our first orders of business this week: watching for a bond weakness in the event of stock market stability.
MBS Pricing Snapshot
Pricing shown below is delayed, please note the timestamp at the bottom. Real time pricing is available via MBS Live.
102-31 : +0-04
0.6544 : -0.0396
|Pricing as of 9/21/20 10:04AMEST|
Tomorrow’s Economic Calendar