Are bonds rallying with stocks? Bond price performance vs stocks
One of the factors investors look at to determine if a stock market rally is sustainable is to observe the behaviour of bonds. Many bottoms in stocks seem to have been marked by a bottom in bonds as well. But I should note that this is not always the case since stocks and bonds live in different universes and can be impacted by different factors. For example, stocks sometimes rally* on inflation whereas bonds sell off. My feeling right now is that a stock market rally is not sustainable unless bonds also rally.
Even if one expects bonds to rally along with stocks, the timing may not be the same. It is rare for stocks and bonds to all hit the bottom at the same time.
Anyway, let's see how bonds have done during three different time periods. For simplicity and because I don't really have access to professional tools that can plot total return, I will simply plot various bond ETFs offered by iShares against the S&P 500 ETF. Total return for bonds, which generally pay out interest consistently, will be slightly higher than what is shown below.
The following ETFs are plotted:
IVV: S&P 500 (this is the candlestick plot)
TLT: 20 year Treasury
AGZ: Agency
TIP: TIPS
AGG: Barclays Aggregate (broad corporate)
LQD: iBoxx Barclays Investment-grade
HYG: iBoxx Barclays High-yield
One Year Comparison
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The candlestick chart is the S&P 500 ETF, whereas the others represent various bond ETFs representing government, agency, and corporate bonds. When looking at these charts, do keep in mind that bonds rarely ever lose money so small declines are significant. So the -10% loss on the investment grade bonds (LQD; the tan line near the middle) is a big loss.
The first chart, showing an year, should give a rough idea of how various bonds have behaved since the crazy period in September/October when we had a whole bunch of bank seizures, Lehman bankruptcy, and collapse of AIG. A lot of these events were unfolding for many months--anyone following bond insurers would have seen a slow motion train track unfolding--but the final bottom fell out with the Lehman bankruptcy.
The thing that pops out from the chart is the massive rally in the 20 year Treasuries (TLT). That 30% move is literally a decade worth of returns for a bond investor! The long-term government bond has sold off since the beginning of the year and seems to be stabilizing near the level it was at early last year.
Fittingly, stocks (IVV), being the risky security, sold off the most. Junk bonds also sold off sharply. Stocks and junk bonds are still down significantly compared ot early last year.
The rest of the bond complex dropped in October of last year but have recovered and seem to be stabilizing. They are at levels slightly below that of early last year.
My conclusion from this chart is that, apart from stocks and junk bonds, bonds are slowly inching their way back to pre-crisis levels. This is consistent with other metrics one may have seen, such as the tightening of the TED spread, declining commercial paper yields, and so forth. Things seem to be improving. However, I should note that there is heavy government intervention--there always is during crises--and we may not be observing signals provided by the free market**. For instance, a lot of the bonds that have rallied are government or agency bonds, or even some corporate bonds, that are being protected by massive goverment spending. I'm not against the governmetn spending plans necessarily but am just pointing out that, for example, agency bonds will rally if the government provides a blanket guarantee all of a sudden (as was the case with Fannie and Freddie being nationalized.)
Year-To-Date Comparison
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The year-to-date chart shows that stocks declined significantly and, as usual, the junk bond ETF tracks the S&P 500 fairly well. There was strong pressure on all the bonds. The bonds are negative in price-only terms (some of them will likely be up if you include interest.) This chart also seems to show the bond ETFs declining slightly over time but it's hard to draw a conclusion given the short time period.
This chart also shows how, apart from the junk bond, there seems to be very little correlation between the S&P 500 and the bond ETFs. The S&P 500 started rallying in the last month after the sharp decline, but the bonds don't appear to be rallying.
Comparison Since the March '09 Bottom
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This chart is roughly from the bottom of the recent stock market rally. I don't know what should be counted as the bottom--the day of the bottom or the next day?--but I went with March 6th.
You can clearly tell that bonds have not rallied at all (except for the junk bond of course.) The bond ETFs are essentially flat. This does not look too bullish to me. But do keep in mind that bonds did not fall as much as stocks recently so it's possible that bonds may not see much improvement for a while.
It should also be noted that this time period is way too short so this is just a preliminary observation.
Conclusion
It seems that bonds have recovered since the October sell-off. However, they have not rallied with stocks in the last month. This seems bearish, especially given how bond yields are still quite high and businesses still have to pay those high interest payments if they re-finance. But the time frame is too short and I think caution is warranted.
FOOTNOTES:
(* Contrary to the popular view, stocks do not always hedge against inflation. Stocks had an extremely difficult time during the high inflation of the 70's and early 80's. Everyone knew inflation was a big problem and were hunting for inflation-resistant companies but very few found any. Warren Buffett has pointed out that companies that can raise prices during inflationary periods will do well, but there are very few companies that can really do that in practice. What seems like an inflation hedge often turns out to be weak... Conventional lore in the investment world is often true for 90% of the time but turns out to be false when you really need it during the 10%. A good example now is how liquor companies were thought to be recession resistant but any shareholder of Diageo, Constellation Brands, or Fotune Brands will know firsthand how these stocks are down as much as economically-sensitive cyclicals.)
(** The same thing applies to stocks as well. If s government throws money at the stock market, it will rally. Such a rally would not necessarily imply that the economy or the long-term future is improving; all it means is that shareholders of various companies that are impacted are receiving money. Right now, the health of the banking system is difficult to determine. Stocks have rallied recently but it's not clear if that is due to government bailouts or genuine improvement in fundamentals. This point may not be important for short-term investors but is crucial to long-term investors. If the stock market rallies because it is being propped up, it may fall later on and hurt anyone that invested money. After all, we definitely don't want to end up in a situation similar to the one in the 90's and end up buying stock in a Japanese bank simply because it was rallying. Anyone that invested in many of the Japanese banks ended up losing their shirt.)
Even if one expects bonds to rally along with stocks, the timing may not be the same. It is rare for stocks and bonds to all hit the bottom at the same time.
Anyway, let's see how bonds have done during three different time periods. For simplicity and because I don't really have access to professional tools that can plot total return, I will simply plot various bond ETFs offered by iShares against the S&P 500 ETF. Total return for bonds, which generally pay out interest consistently, will be slightly higher than what is shown below.
The following ETFs are plotted:
IVV: S&P 500 (this is the candlestick plot)
TLT: 20 year Treasury
AGZ: Agency
TIP: TIPS
AGG: Barclays Aggregate (broad corporate)
LQD: iBoxx Barclays Investment-grade
HYG: iBoxx Barclays High-yield
One Year Comparison
.gif)
The candlestick chart is the S&P 500 ETF, whereas the others represent various bond ETFs representing government, agency, and corporate bonds. When looking at these charts, do keep in mind that bonds rarely ever lose money so small declines are significant. So the -10% loss on the investment grade bonds (LQD; the tan line near the middle) is a big loss.
The first chart, showing an year, should give a rough idea of how various bonds have behaved since the crazy period in September/October when we had a whole bunch of bank seizures, Lehman bankruptcy, and collapse of AIG. A lot of these events were unfolding for many months--anyone following bond insurers would have seen a slow motion train track unfolding--but the final bottom fell out with the Lehman bankruptcy.
The thing that pops out from the chart is the massive rally in the 20 year Treasuries (TLT). That 30% move is literally a decade worth of returns for a bond investor! The long-term government bond has sold off since the beginning of the year and seems to be stabilizing near the level it was at early last year.
Fittingly, stocks (IVV), being the risky security, sold off the most. Junk bonds also sold off sharply. Stocks and junk bonds are still down significantly compared ot early last year.
The rest of the bond complex dropped in October of last year but have recovered and seem to be stabilizing. They are at levels slightly below that of early last year.
My conclusion from this chart is that, apart from stocks and junk bonds, bonds are slowly inching their way back to pre-crisis levels. This is consistent with other metrics one may have seen, such as the tightening of the TED spread, declining commercial paper yields, and so forth. Things seem to be improving. However, I should note that there is heavy government intervention--there always is during crises--and we may not be observing signals provided by the free market**. For instance, a lot of the bonds that have rallied are government or agency bonds, or even some corporate bonds, that are being protected by massive goverment spending. I'm not against the governmetn spending plans necessarily but am just pointing out that, for example, agency bonds will rally if the government provides a blanket guarantee all of a sudden (as was the case with Fannie and Freddie being nationalized.)
Year-To-Date Comparison
.gif)
The year-to-date chart shows that stocks declined significantly and, as usual, the junk bond ETF tracks the S&P 500 fairly well. There was strong pressure on all the bonds. The bonds are negative in price-only terms (some of them will likely be up if you include interest.) This chart also seems to show the bond ETFs declining slightly over time but it's hard to draw a conclusion given the short time period.
This chart also shows how, apart from the junk bond, there seems to be very little correlation between the S&P 500 and the bond ETFs. The S&P 500 started rallying in the last month after the sharp decline, but the bonds don't appear to be rallying.
Comparison Since the March '09 Bottom
.gif)
This chart is roughly from the bottom of the recent stock market rally. I don't know what should be counted as the bottom--the day of the bottom or the next day?--but I went with March 6th.
You can clearly tell that bonds have not rallied at all (except for the junk bond of course.) The bond ETFs are essentially flat. This does not look too bullish to me. But do keep in mind that bonds did not fall as much as stocks recently so it's possible that bonds may not see much improvement for a while.
It should also be noted that this time period is way too short so this is just a preliminary observation.
Conclusion
It seems that bonds have recovered since the October sell-off. However, they have not rallied with stocks in the last month. This seems bearish, especially given how bond yields are still quite high and businesses still have to pay those high interest payments if they re-finance. But the time frame is too short and I think caution is warranted.
FOOTNOTES:
(* Contrary to the popular view, stocks do not always hedge against inflation. Stocks had an extremely difficult time during the high inflation of the 70's and early 80's. Everyone knew inflation was a big problem and were hunting for inflation-resistant companies but very few found any. Warren Buffett has pointed out that companies that can raise prices during inflationary periods will do well, but there are very few companies that can really do that in practice. What seems like an inflation hedge often turns out to be weak... Conventional lore in the investment world is often true for 90% of the time but turns out to be false when you really need it during the 10%. A good example now is how liquor companies were thought to be recession resistant but any shareholder of Diageo, Constellation Brands, or Fotune Brands will know firsthand how these stocks are down as much as economically-sensitive cyclicals.)
(** The same thing applies to stocks as well. If s government throws money at the stock market, it will rally. Such a rally would not necessarily imply that the economy or the long-term future is improving; all it means is that shareholders of various companies that are impacted are receiving money. Right now, the health of the banking system is difficult to determine. Stocks have rallied recently but it's not clear if that is due to government bailouts or genuine improvement in fundamentals. This point may not be important for short-term investors but is crucial to long-term investors. If the stock market rallies because it is being propped up, it may fall later on and hurt anyone that invested money. After all, we definitely don't want to end up in a situation similar to the one in the 90's and end up buying stock in a Japanese bank simply because it was rallying. Anyone that invested in many of the Japanese banks ended up losing their shirt.)
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