What is the correlation between stocks and bonds over time?
The rolling 24-month correlation reached a 28-year high of 72% in September 2022, and correlation averaged 65% from January 2021 to March 2023. From 1976 to 2021, every year that stocks were down bond returns were positive, providing a ballast for the return on a traditional 60/40 portfolio*.
A positive correlation between equity and bond returns can partly explain the increase in bond yields observed over the past months. The hallmark portfolio structure of passive investors includes government bonds as a hedge against the swings of riskier assets such as equities.
Growth and volatility shocks tend to push stocks and bonds in opposite directions, while inflation shocks tend to cause common discount rate variation across asset classes. The latter effect dominated in the variable inflation levels of 1960–1990 and kept stock-bond correlations positive.
For example, while the average five-year correlation since 2000 has been -0.35, the longer-term average since 1926 is +0.06. Moreover, the correlation was positive in most five-year periods between 1931–1955 and 1970–1999 (Figure 1).
Stocks can be positively correlated when they move up or down in tandem. A correlation value of 1 means two stocks have a perfect positive correlation. If one stock moves up while the other goes down, they would have a perfect negative correlation, noted by a value of -1.
The only other times that both stocks and bonds have declined simultaneously were in April and September of 2022—the beginning and the bottom of last year's bear market; January of 2009 in the ashes of the Great Financial Crisis; and October of 1979 following nearly a decade of ultra-high interest rates.
The rule of thumb advisors have traditionally urged investors to use, in terms of the percentage of stocks an investor should have in their portfolio; this equation suggests, for example, that a 30-year-old would hold 70% in stocks and 30% in bonds, while a 60-year-old would have 40% in stocks and 60% in bonds.
In theory, rising stock prices draw investors away from bonds, causing bond prices to drop, as sellers lower prices to appeal to market participants. Since bond prices and bond yields move inversely, eventually, the falling bond prices would push the bond yields high enough to attract investors.
Broader market conditions can have an impact on bonds. For example, if the stock market is rising, investors typically move out of bonds and into equities. By contrast, when the stock market is going through a correction, investors may seek the perceived safety of bonds.
Stocks and bonds typically move in opposite directions because they are fighting for the same money from investors. When investors use their money to buy stocks, they have that much less with which to buy bonds. Conversely, when investors use their money to buy bonds, they have that much less with which to buy stocks.
What happens to bonds and stocks when interest rates rise?
When rates go up, bond prices typically go down, and when interest rates decline, bond prices typically rise. This is a fundamental principle of bond investing, which leaves investors exposed to interest rate risk—the risk that an investment's value will fluctuate due to changes in interest rates.
But when risk appetite is high, investors tend to buy equities and sell bonds. This “risk-on, risk-off” behaviour causes equity and bond risk premia to regularly diverge and is supportive of a negative equity-bond correlation.
Higher interest rates tend to negatively affect earnings and stock prices (with the exception of the financial sector). Higher interest rates also mean future discounted valuations are lower as the discount rate used for future cash flow is higher.
For example, 0.15 might be considered a "weak positive correlation," whereas 0.90 might be considered a "strong positive correlation." On the other hand, -0.50 might be considered "moderate negative correlation," while -0.85 might be referred to as "strong negative correlation."
A correlation of 1.00 indicates perfect correlation, while lower numbers indicate that the asset classes are not correlated and generally do not move in tandem with each other—or, when the market moves down, these asset classes may not fall as much as the market in general, which could mitigate risk in your portfolio.
A high correlation between two companies often means that there is a strong relationship between their financial performance. For example, if one company's stock increases in value, it is likely that the other company's stock may also increase in value as well.
Higher bond yields can lead to lower share prices
Naturally, as more investors sell their stock, the further share prices could fall. Here, you can see the inverse relationship between stocks and bonds, where the value of the S&P 500 and a US Treasury bond tend to move in opposite directions.
The short answer is bonds tend to be less volatile than stocks and often perform better during recessions than other financial assets.
Do Bonds Lose Money in a Recession? Bonds can perform well in a recession as investors tend to flock to bonds rather than stocks in times of economic downturns. This is because stocks are riskier as they are more volatile when markets are not doing well.
The 70/30 rule is a guideline for managing money that says you should invest 70% of your money and save 30%. This rule is also known as the Warren Buffett Rule of Budgeting, and it's a good way to keep your finances in order.
How much should a 75 year old have in stocks?
But now that Americans are living longer, that formula has changed to 110 or 120 minus your age — meaning that if you're 75, you should have 35% to 45% of your portfolio in stocks. Using this formula, if your portfolio totals $100,000, then you should have no less than $35,000 in stocks and no more than $45,000.
The truth is that most investors won't have the money to generate $1,000 per month in dividends; not at first, anyway. Even if you find a market-beating series of investments that average 3% annual yield, you would still need $400,000 in up-front capital to hit your targets. And that's okay.
Historically, when stock prices rise and more people are buying to capitalize on that growth, bond prices typically fall on lower demand. Conversely, when stock prices fall, investors want to turn to traditionally lower-risk, lower-return investments such as bonds, and their demand and price tend to increase.
For most of the past 20 years stock prices and bond prices tended to move in opposite directions. This made buying 10-year Treasury bonds a good hedge for investors seeking to protect their portfolio from declining stock prices.
Unless you are set on holding your bonds until maturity despite the upcoming availability of more lucrative options, a looming interest rate hike should be a clear sell signal.
