Stocks and bonds move in opposite directions and improve results? Really?

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Johno
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Johno »

Dude2 wrote:I wouldn't define risk as standard deviation. I'd use standard deviation as a measure of volatility. To me risk is that nebulous factor that we can never really quantify. Given efficient and sane markets, higher recognized risk demands higher returns, and hopefully the market keeps on top of that. If risk is changing, even as my AA is fixed, then what conclusions can I draw about anything? That is all I was trying to express. We may have some disagreements even in this thread about whether the rebalancing bonus exists, but those that believe it does exists believe it is small. Something small may be able to be explained by other factors, like varying risk, luck, timing.
Once again 'rebalancing bonus' has no relation to risk, no matter how you define risk, because it merely benchmarks the return of something you can do, periodically rebalance a portfolio to X% stock and (100-X%) bonds, to a simple return measure of something you can't actually do, 'just give me X%*stock return + (100-X%)*bond return'.

And there's no doubt a significant 'reblancing bonus' has existed for loosely correlated assets like stocks and bonds, though like any other past result it's not gteed to exist or be any particular amount in the future. OTOH on a forward looking basis you don't know the individual returns of the components of a portfolio anyway. But it seems it might not be redundant to keep repeating: all 'rebalancing bonus' means is if return of a portfolio periodically rebalanced to given weights exceeds the weighted return of the individual components. It doesn't compare different strategies you could actually implement, and thus the 'risk/return of the rebalancing bonus' is a meaningless concept.

The risk/return of actual strategies which vary the components weights over time (to maintain constant risk, based on trend following, etc) is a different question, nothing directly to do with 'rebalancing bonus' as the term has been understood.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by roflwaffle »

edge wrote:I would really have to see exactly how you got to these numbers but they seem very very way off. From 1928 - 2014 the geomean of stocks was 9.7%. The geomean of 10 year treasuries was 5.3%. (http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html)

There is simply no way that you end up with the same number with a 60/40 portfolio over a long period of time (30-40+ years).

In portfolio visualizer from 1988 (could have used 1985) to 2011 (could have used 2015) a 100% VFINX portfolio starting at 10k has a final balance of 85k while a 60/40 VFINX/VBMFX rebalanced annually is 77k. A difference in total return of around 10%.

Expanding to 1985-2015 VFINX goes to 159k and 60/40 VFINX/VBMFX goes to 117k, a difference of almost 36%. As time frames are elongated, this number gets larger and larger. The equity risk premium over 10 year treasuries from 1928 to 2014 was over 4.5%. This is not surmountable in a portfolio that held substantial amount of bonds.
I'm not comparing 100% stocks to 100% 10-year treasuries, I'm comparing 100% stocks to 60% stocks/40% 10-year treasuries rebalanced annually. If you want to reproduce what I'm referring to, just grab the spreadsheet I linked in my last post and create entries for 100% stocks and 60% stocks/40% treasuries with yearly rebalancing from 1918 until the last entry of the spreadsheet. :beer

PS - I'm not sure why you're using VBMFX in your 85-15 comparison. It performed worse than VFINX, which performed worse than the S&P 500 Total returns over the same time period. A 60/40 portfolio does perform worse (~24% off of the S&P) over the same time period, but it's not as bad as VBMFX. More to the point, I'm not sure if a bond fund will have the same stabilizing effect 10-year treasuries do. But yeah, just grab Schiller's spreadsheet and see for yourself.

Code: Select all

Portfolio Returns

Portfolio performance statistics
Portfolio				Initial Balance	Final Balance	CAGR	Std.Dev.	Best Year	Worst Year
Portfolio 1				$10,000		$152,008 		10.60% 	18.05%	35.79%	-37.04%
Portfolio 2				$10,000		$124,339 		9.78% 	10.47%	30.87%	-14.18%	
S&P 500 Total Return	$10,000		$152,559 		10.62% 	17.99%	37.58%	-37.00%
edge
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

Now I'm sure you are totally confused. VFINX is the premier S&P 500 index fund. It has over 430 billion in assets, maybe you have heard of it. VBMFX is the total bond fund...sorta the same story. The numbers I gave are for a 60/40 portfolio vs all stocks.

Sorry but at this point I pretty much have to write off everything you post.

roflwaffle wrote:
edge wrote:I would really have to see exactly how you got to these numbers but they seem very very way off. From 1928 - 2014 the geomean of stocks was 9.7%. The geomean of 10 year treasuries was 5.3%. (http://pages.stern.nyu.edu/~adamodar/Ne ... retSP.html)

There is simply no way that you end up with the same number with a 60/40 portfolio over a long period of time (30-40+ years).

In portfolio visualizer from 1988 (could have used 1985) to 2011 (could have used 2015) a 100% VFINX portfolio starting at 10k has a final balance of 85k while a 60/40 VFINX/VBMFX rebalanced annually is 77k. A difference in total return of around 10%.

Expanding to 1985-2015 VFINX goes to 159k and 60/40 VFINX/VBMFX goes to 117k, a difference of almost 36%. As time frames are elongated, this number gets larger and larger. The equity risk premium over 10 year treasuries from 1928 to 2014 was over 4.5%. This is not surmountable in a portfolio that held substantial amount of bonds.
I'm not comparing 100% stocks to 100% 10-year treasuries, I'm comparing 100% stocks to 60% stocks/40% 10-year treasuries rebalanced annually. If you want to reproduce what I'm referring to, just grab the spreadsheet I linked in my last post and create entries for 100% stocks and 60% stocks/40% treasuries with yearly rebalancing from 1918 until the last entry of the spreadsheet. :beer

PS - I'm not sure why you're using VBMFX in your 85-15 comparison. It performed worse than VFINX, which performed worse than the S&P 500 Total returns over the same time period. A 60/40 portfolio does perform worse (~24% off of the S&P) over the same time period, but it's not as bad as VBMFX. More to the point, I'm not sure if a bond fund will have the same stabilizing effect 10-year treasuries do. But yeah, just grab Schiller's spreadsheet and see for yourself.

Code: Select all

Portfolio Returns

Portfolio performance statistics
Portfolio				Initial Balance	Final Balance	CAGR	Std.Dev.	Best Year	Worst Year
Portfolio 1				$10,000		$152,008 		10.60% 	18.05%	35.79%	-37.04%
Portfolio 2				$10,000		$124,339 		9.78% 	10.47%	30.87%	-14.18%	
S&P 500 Total Return	$10,000		$152,559 		10.62% 	17.99%	37.58%	-37.00%
Last edited by edge on Sun Dec 06, 2015 3:11 pm, edited 1 time in total.
roflwaffle
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by roflwaffle »

I would suggest against writing off something without first testing it, but it's your call. :beer
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

roflwaffle wrote:I would suggest against writing off something without first testing it, but it's your call. :beer

I have tested it several different ways. It is off by a country mile.

(Ref to trinity study removed, confusing because it used corporate bonds)
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siamond
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by siamond »

OP, you are absolutely right, and the SBBI book itself shows such correlation numbers if I remember well. No negative correlation indeed.
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siamond
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by siamond »

OP, you are absolutely right, and the SBBI book itself shows such correlation numbers if I remember well. No negative correlation indeed.

PS. I command you for analyzing the numbers yourself, and challenge some 'common wisdom' that is often repeated and may not be quite right. This is really the best way to understand this stuff, be skeptical and analyze by yourself.
Day9
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Day9 »

It is trivial to conclude 100% stock has higher long term returns than 60% stock/40% bond. *Yawn*

More interesting would be to compare an unlevered 100% stock portfolio with a modestly levered 60/40 portfolio.
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grap0013
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by grap0013 »

I'll confess I haven't read every post in this thread but I'll admit I'm shocked by many of the answers. Without a doubt, when stocks take a big hit treasury bonds typically go up. Not always but most of the time. You can see this clearly in 2008/2009. Furthermore, just look at this on a daily basis. With larger than 1% equity drops for example I look at IEF (intermed treasury bond ETF) and it is almost always up. I do not need some equation to tell me this. I just see it. Take a look for yourself.

It does not matter much what bonds do when stocks are doing well. They matter most when stocks are doing poorly and they do behave nicely when that occurs.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Angelus359 »

Dude2 wrote:
Angelus359 wrote:One question that I don't see answered here is what happens to returns if you keep an 80/20 stock bond ratio, precisely, and rebalance every quarter (when dividends are paid) using dividends if possible or sales if you must.

Annual might not be often enough to really take advantage of the concept

A sudden dip in stocks, where you then simply buy more stocks, or a spike in stocks where you buy more bonds might beat stocks over time?
The invisible variable in the equation is the amount of risk. We have to make a leap of faith and say to ourselves that if we stay with 80/20 that we have maintained a constant risk level. Given that, when stocks tanked, we sold bonds high to buy stocks low. When bonds tanked, we sold stocks high to buy bonds low. I agree that we should come out ahead with that strategy when it is related to an associated risk factor. The Vanguard funds that offer a fixed asset allocation rebalance themselves smartly on a daily(ish) basis (taxes, fees are all considerations). We should be able to use those funds as role models, i.e. compare the total return of the combined TSM/TBM at some ratio to the total return of Balanced Index over some time period.

VBINX (Vanguard Balanced Index) start 1993 - present total return --> 10,000 becomes 58,346
TSM start 1993 - present 74,660
TBM start 1993 - present 23,700 --> 0.6 * 74,660 + 0.4 * 23,700 = 54,276

That is the time frame that was convenient. I'm sure we can argue endlessly about why the time frame biases the results.
I wonder if there is an optimal ratio of risk vs reward here

There are 4 vanguard lifestyle funds that are similar
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grap0013
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by grap0013 »

Speak of the devil. We are 24 minutes into the trading day. Global equities are all down and IEF is +0.17%.
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siamond
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by siamond »

grap0013 wrote:I'll confess I haven't read every post in this thread but I'll admit I'm shocked by many of the answers. Without a doubt, when stocks take a big hit treasury bonds typically go up. Not always but most of the time. You can see this clearly in 2008/2009. Furthermore, just look at this on a daily basis. With larger than 1% equity drops for example I look at IEF (intermed treasury bond ETF) and it is almost always up. I do not need some equation to tell me this. I just see it. Take a look for yourself.
Let's take a look indeed, using a long historical perspective. Source is SBBI/Ibbotson, large-caps vs IT bonds, nominal returns. If we look at the troubled past 15 years, you are perfectly correct. Now look at the 1990-2000 period, interesting, bonds moved in perfect unison with stocks. Look at the oil crisis, mid-70s, bonds didn't exactly help. 1929 and 1937 crisis, meh. Etc. The so-so historical correlation math does seem confirmed by 'eyeballing'. Actually when running the numbers over recent decades, the correlation does become negative (as you perceived).

Now the question is: is the Fed now skilled enough that such recent negative correlation will stay for good, or is this just recency bias, and we should not forget the past? Don't know.

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grap0013
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by grap0013 »

viewtopic.php?t=2409

Treasury bonds worked pretty well during the 2 largest financial collapses in the US during the last 90 years. Good enough to convince me.
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nisiprius
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by nisiprius »

It's striking that on the one hand, we're told that there is a "flight-to-safety" effect that is implied to be reliable, persistent, and not accidental, between long-term Treasuries and stocks... and, on the other hand, for the last decade or so, that U.S. Treasury credit quality is shaky (OMG, downgraded to AA+ by one of the four ratings agencies) and that there is an ominous bond bubble, specifically in Treasuries.

Image

In 2011 much was made of the fact that bond genius Bill Gross had taken PIMCO Total Return completely out of treasuries, often with an implication that we'd all be well advised to do the same. (Bill Gross's action did not turn out well).

Image

Of course, these two ideas are not contradictory. We could believe both that

a) people are idiots to flee to Treasuries, thinking they're safe, when they aren't, but...
b) those idiots, they'll do it every time. Bank on it.

However, I think it's much more likely that Treasuries continue to be quite safe, that it's hard to predict what investors will do or determine why they've done it even after the fact, and you can no more predict the duration of, let's call it a "secular" negative correlation than the duration of a secular bull or bear market.

It's reasonable to rely on Treasuries not to default; it's not reasonably to rely on them to actively cancel out stock risk.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by garlandwhizzer »

I confess I haven't read all the posts but I'll just toss in my two cents worth here.

In times of moderate market action, without extreme events, the relationship between stock and Treasury performance may be variable. In extreme negative events like Black Swans, the Great Depression, and the Great Recession of 2008-9, when fear becomes massive and drives all investors in one direction, to sell, correlations between all risk assets approach I.0. There is no safe place to hang out in the risk asset arena. Panic driven selling devastates LC, SC, INTL DM, REITS, commodities, and especially EM. Even high grade corporate bonds get hit in such circumstances in the mad search for safety. That frantic pursuit for a safe asset completely immune to market forces during crisis, drives lots of money from both US and INTL sources into Treasuries which are denominated in the world's reserve currency (which also tends to hold up better relative to other currencies during crisis) and are backed by the full faith and credit of the dominant political power in the world which can rely on printing presses if necessary to pay off its obligations. Hence Treasuries tend to appreciate in price during crisis when a portfolio gets devastated, in short when you need safety most.

For this reason alone I believe it important to construct a bond portfolio that includes Treasuries at a sufficient level to allow one to sleep at night during crisis. Historically in the past 30+ year bull market in bonds, Treasuries provided not only safety but very significant real returns. I do not believe that they will provide such positive returns in the future, but they will continue to be the safest harbor in a truly severe storm. The percentage of Treasuries in ones bond portfolio is an individual decision based on ones risk tolerance, goals, etc.. Personally I hold both Treasuries for safety and investment grade corporates for better expected future returns in my portfolio. TBM also has a good mix of both safety and bond return prospects in my opinion. I expect the bond bull market is over and all bond returns are likely to be very muted for the foreseeable future. Nonetheless safe bonds even given today's low yields continue to play an important role in future, providing emotional balm at the point of maximal pain.

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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Dude2 »

garlandwhizzer wrote:For this reason alone I believe it important to construct a bond portfolio that includes Treasuries at a sufficient level to allow one to sleep at night during crisis.
Do you consider TIPS to be included in that bucket? They are treasuries, but I'm not sure if you get the same flight to quality effect. When I look at the charts it isn't easy to tell.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Day9 »

Dude2 wrote:Do you consider TIPS to be included in that bucket? They are treasuries, but I'm not sure if you get the same flight to quality effect. When I look at the charts it isn't easy to tell.
The (nominal) treasury market is perhaps the most liquid market in the history of the world, next to currency markets. This is one of the reasons they are a safe haven, especially during liquidity crises. The TIPS market just doesn't have this kind of liquidity.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by roflwaffle »

edge wrote:
roflwaffle wrote:I would suggest against writing off something without first testing it, but it's your call. :beer
I have tested it several different ways. It is off by a country mile.

(Ref to trinity study removed, confusing because it used corporate bonds)
Rude comments aside, you can DL the Schiller data and run the numbers yourself to determine whether they're accurate. Comparing two relatively new funds over a time period of 26 years to a S&P composite/10-year treasuries over 93 years probably isn't rigorous enough to evaluate my claim.

I'm not saying I didn't make a mistake, maybe I did, maybe I didn't. But with respect, I really doubt going to find that mistake by analyzing data from another source. :beer
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

All the sources say the same thing. The difference between long term total return performance of 60:40 stocks:bonds and 100 stocks is not 6%, not even close.

What exactly is rude about saying you are wrong? I also find it extremely odd that you 'expect' different sources of data to give vastly different answers. That really isn't how it works. If you are getting materially different answers from different sources that report the same data (stock returns, bond returns) - you are probably doing something wrong.

roflwaffle wrote:
edge wrote:
roflwaffle wrote:I would suggest against writing off something without first testing it, but it's your call. :beer
I have tested it several different ways. It is off by a country mile.

(Ref to trinity study removed, confusing because it used corporate bonds)
Rude comments aside, you can DL the Schiller data and run the numbers yourself to determine whether they're accurate. Comparing two relatively new funds over a time period of 26 years to a S&P composite/10-year treasuries over 93 years probably isn't rigorous enough to evaluate my claim.

I'm not saying I didn't make a mistake, maybe I did, maybe I didn't. But with respect, I really doubt going to find that mistake by analyzing data from another source. :beer
Last edited by edge on Mon Dec 07, 2015 3:37 pm, edited 1 time in total.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by nisiprius »

garlandwhizzer wrote:...In extreme negative events like Black Swans, the Great Depression, and the Great Recession of 2008-9, when fear becomes massive and drives all investors in one direction, to sell, correlations between all risk assets approach I.0. There is no safe place to hang out in the risk asset arena...
Why do you say this? During 2008-2009, Total Bond seemed like a pretty darned "safe place to hang out," to me. This is a point that people often seem to ignore amongst all the hate for bonds in general and Total Bond in particular.

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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

While safe bonds were a much better place to be, I believe total bond also fell with stocks during the most violent declines of 2008. However, they fell far less, fell after stocks had long begun their decline, and rebounded once the worst of the crisis was over.

My guess is that only the shortest government securities and cash (in strong/safe currencies) do well when in the thick of the worst of this kind of crisis. However, elongating timelines beyond the deepest of the dark days shows a better picture for bond behavior.

I would postulate it is a natural progression. The riskiest assets fall, if the crisis widens/worsens, then the next risky fall as capital searches for safety and tries to avoid loss, and so on until you get to cash. And if that goes - game over.
nisiprius wrote:
garlandwhizzer wrote:...In extreme negative events like Black Swans, the Great Depression, and the Great Recession of 2008-9, when fear becomes massive and drives all investors in one direction, to sell, correlations between all risk assets approach I.0. There is no safe place to hang out in the risk asset arena...
Why do you say this? During 2008-2009, Total Bond seemed like a pretty darned "safe place to hang out," to me. This is a point that people often seem to ignore amongst all the hate for bonds in general and Total Bond in particular.

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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by DonCamillo »

Frans wrote:If there were no correlation between the directions of movement between these asset classes and we had a large sample size (and 86 years is not a large sample size) then we would expect that number to be close to 50%. It's unclear whether this deviation from 50% is caused by the alleged correlation or statistical variation due to a small sample size.
And nisiprius said;
The other issue is that, seemingly, financial people don't understand sampling variation, and assume that any period of observed negative correlation must be a real phenomenon, not just the luck of the sample.
One of the issues that concerns me in looking at returns over the years for stock and bonds is the decided lack of independence between adjacent years. One reason that 86 years is not a large sample size is that adjacent years in the sample have common factors that influence the returns of both stocks and bonds. This includes both multiyear madness of crowds such as the stock frenzies of the late 1920s and the late 1990s, extended traumatic events like the depression and World War II, shocks like the oil price shock of the 1970's and 9/11, and asset bubbles like the dot com collapse in 2000 to 2003 and the sub-par mortgage collapse in 2007 to 2009. In particular, there are times when capital is in great demand such as the rebuilding after World War II, times when capital is plentiful like the present period of quantitative easing, and times when it is difficult to find profitable opportunities to deploy capital such as the Depression. The demand for capital influences both stocks and bonds in ways that undermine independence between those asset classes.

I am very skeptical about trying to find correlations in data with so many influencing factors. I am even more skeptical when many people are looking at the data and trying to profit from anomalies like the value premium, because any identified premium should be arbitraged away and lose its predictive value.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Maynard F. Speer »

It's always difficult to predict what the next flight-to-safety asset will be ... Many are still betting on gold - in the past, various commodities have gone in and out of favour ... Through 2008, about the best places to be were the Yen and the Swiss franc (and LT treasuries did pretty well too)

And getting this right is essentially what the much (imo unfairly) maligned Global Macro funds seek to do

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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by roflwaffle »

edge wrote:All the sources say the same thing. The difference between long term total return performance of 60:40 stocks:bonds and 100 stocks is not 6%, not even close.

What exactly is rude about saying you are wrong? I also find it extremely odd that you 'expect' different sources of data to give vastly different answers. That really isn't how it works. If you are getting materially different answers from different sources that report the same data (stock returns, bond returns) - you are probably doing something wrong.
The rude part is misrepresenting someone's position and using that as justification for criticism. I never made any claims about a 100% VFINX versus a 60% VFINX/VBMFX portfolio from 1985-2015, I made a claim about Schiller's S&P Composite from 1918 to 2011 and US Treasuries. Comparing the two is apples to oranges.

Here's something much closer from PV (It includes treasuries ;)).

https://www.portfoliovisualizer.com/bac ... TNotes2=40

Comparing Schiller's data to PV the US Market/10-year treasuries isn't ideal either because it uses different stock data and only goes back to 1972, but it's a lot closer than VFINX/VBMFX (rebalancing with VBMFX in particular performs poorly compared to treasuries). 100% stock versus 60% stock/40% 10-year treasuries rebalanced annually from 1972 to 2011 results in a 9.5% gap. It's a few percent higher than my 6.5% because the market data is different and it's over a different time period, but it's no country mile either. If you really want to compare results, go grab Schiller's spreadsheet and do a few runs yourself using the same data.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by nisiprius »

DonCamillo wrote:
Frans wrote:If there were no correlation between the directions of movement between these asset classes and we had...One of the issues that concerns me in looking at returns over the years for stock and bonds is the decided lack of independence between adjacent years. One reason that 86 years is not a large sample size is that adjacent years in the sample have common factors that influence the returns of both stocks and bonds. This includes both multiyear madness of crowds such as the stock frenzies of the late 1920s and the late 1990s, extended traumatic events like the depression and World War II, shocks like the oil price shock of the 1970's and 9/11, and asset bubbles like the dot com collapse in 2000 to 2003 and the sub-par mortgage collapse in 2007 to 2009...
Indeed. Although there is a problem with trying to read too much into the seemingly straight line segments, and there are other issues with it--it's the raw DJIA, without reinvested dividends or inflation correction--I still think Jim Otar's chart is worth internalizing:

Image

This also fits the intuitive view of some old-time technical analyst types, notably the late Richard Russell of the "Dow Theory Letter," who--according to Maggie Mahar in her book "Bull!", regarded "the" market as an episodic succession of markets, plural. Each "market," according to Russell, had a birth, life, and death of its own, and its own psychology and dynamics while it lasted.

Rather alarmingly, Maggie Mahar wrote in her book:
It seems that a new market cannot begin until the last bull's heart has been broken, and typically it takes more than one crash to do the job.
I don't buy this at all if the idea is to predict the time course of each of these "markets" and get in and out at the corner points. I don't know whether it's better to talk about a succession of straight-line markets, or just to say that the power spectrum of the stock market has a lot of power in the very low frequencies. Or, better yet, that it is a chaotic system that flips from one state into another, and seems to display stable traditional statistics only while it is one state.

Anyway, I don't think we have 86 data point to do statistics on, and certainly not 365.25 x 86 data points. It's more like eight or nine.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

So, your example shows a gap of ~10%. A 10% gain is approximately 67% more than a 6% gain.

How exactly is using VFINX a bad choice? It is an actual investible asset that mirrors the index vs a make believe one with 0 expenses. The only reason to not use it is if a longer time frame is needed - which in this case admittedly it is. The treasuries thing is debatable but when people say 60:40 they typically do not mean that all the bonds are invested only in a specific treasury duration.

Lastly, the gap would be bigger if it included taxes and the gap is bigger if we don't cherry pick dates and just use the maximum length of time available. In portfolio visualizer this would be 33% using the non-investible stock and non-diversified bond portfolio you selected from 1972 to 2014.

I do not advocate a 100% stock portfolio but we shouldn't kid ourselves that somehow we can approach its performance with 40% in bonds.

What column in Shiller's XLS are you using for 10 year treasury returns? He only has yield in the sheet that I downloaded. This is obviously not the same as return. For example, in 1928 the 10 yr yield was 3.45% but the return was only 0.84%.
roflwaffle wrote:
edge wrote:All the sources say the same thing. The difference between long term total return performance of 60:40 stocks:bonds and 100 stocks is not 6%, not even close.

What exactly is rude about saying you are wrong? I also find it extremely odd that you 'expect' different sources of data to give vastly different answers. That really isn't how it works. If you are getting materially different answers from different sources that report the same data (stock returns, bond returns) - you are probably doing something wrong.
The rude part is misrepresenting someone's position and using that as justification for criticism. I never made any claims about a 100% VFINX versus a 60% VFINX/VBMFX portfolio from 1985-2015, I made a claim about Schiller's S&P Composite from 1918 to 2011 and US Treasuries. Comparing the two is apples to oranges.

Here's something much closer from PV (It includes treasuries ;)).

https://www.portfoliovisualizer.com/bac ... TNotes2=40

Comparing Schiller's data to PV the US Market/10-year treasuries isn't ideal either because it uses different stock data and only goes back to 1972, but it's a lot closer than VFINX/VBMFX (rebalancing with VBMFX in particular performs poorly compared to treasuries). 100% stock versus 60% stock/40% 10-year treasuries rebalanced annually from 1972 to 2011 results in a 9.5% gap. It's a few percent higher than my 6.5% because the market data is different and it's over a different time period, but it's no country mile either. If you really want to compare results, go grab Schiller's spreadsheet and do a few runs yourself using the same data.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

Nsiprius,

As you said, way too few data points and not clear if this view applies out of sample (would be interesting). Also don't think that DJIA is a very good proxy for the market.

I suspect that this pattern does not hold out of sample - my guess.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by roflwaffle »

edge wrote:So, your example shows a gap of ~10%. A 10% gain is approximately 67% more than a 6% gain.

How exactly is using VFINX a bad choice? It is an actual investible asset that mirrors the index vs a make believe one with 0 expenses. The only reason to not use it is if a longer time frame is needed - which in this case admittedly it is. The treasuries thing is debatable but when people say 60:40 they typically do not mean that all the bonds are invested only in a specific treasury duration.

Lastly, the gap would be bigger if it included taxes and the gap is bigger if we don't cherry pick dates and just use the maximum length of time available. In portfolio visualizer this would be 33% using the non-investible stock and non-diversified bond portfolio you selected from 1972 to 2014.

I do not advocate a 100% stock portfolio but we shouldn't kid ourselves that somehow we can approach its performance with 40% in bonds.

What column in Shiller's XLS are you using for 10 year treasury returns? He only has yield in the sheet that I downloaded. This is obviously not the same as return. For example, in 1928 the 10 yr yield was 3.45% but the return was only 0.84%.
VFINX isn't that different than the S&P 500 choice, but because VBMFX isn't good for a comparison, anything with that isn't going to result in an accurate comparison. The point of using 2011 as the end date is because that's where Schiller's spreadsheet ends. In that context picking 2014 as the end date is more cherry picking than picking 2011, but so is using VFINX/VBMFX instead of the S&P 500/treasuries.

I agree about including taxes, although that could push returns from a 60/40 portfolio up versus a portfolio of only stock. How much depends on your tax bracket, but calculating the after (top marginal) tax P/E ratio is why I started at 1918. You can calculate the treasury yield from the 10-year yield, real, and nominal (one-year) interest rates.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

1) I fail to see how a 'Total Bond Index Fund' is 'bad' for a comparison or for use as the bond component of a 60:40 portfolio. Sorry, it sounds silly.

2) VFINX is a (the?) S&P 500 index fund. It is hard to tell but I suppose you are just trolling at this point.

3) In what scenario could a portfolio with 40% nominal bonds be more tax efficient than a 100% total market stock fund? I would love to see the corner case where that occurs. Also, where is this top marginal tax bracket data? It is not in my Shiller spreadsheet...

4) I am not sure why you would calculate treasury yield again, you already have the yield. Maybe you can post your spreadsheet so I can take a look at where you went wrong. The Shiller spreadsheet cannot be used as-is to do the portfolio calculations you are advertising.
roflwaffle wrote: VFINX isn't that different than the S&P 500 choice, but because VBMFX isn't good for a comparison, anything with that isn't going to result in an accurate comparison. The point of using 2011 as the end date is because that's where Schiller's spreadsheet ends. In that context picking 2014 as the end date is more cherry picking than picking 2011, but so is using VFINX/VBMFX instead of the S&P 500/treasuries.

I agree about including taxes, although that could push returns from a 60/40 portfolio up versus a portfolio of only stock. How much depends on your tax bracket, but calculating the after (top marginal) tax P/E ratio is why I started at 1918. You can calculate the treasury yield from the 10-year yield, real, and nominal (one-year) interest rates.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by garlandwhizzer »

garlandwhizzer wrote:
...In extreme negative events like Black Swans, the Great Depression, and the Great Recession of 2008-9, when fear becomes massive and drives all investors in one direction, to sell, correlations between all risk assets approach I.0. There is no safe place to hang out in the risk asset arena...
nisi wrote in response to my post: Why do you say this? During 2008-2009, Total Bond seemed like a pretty darned "safe place to hang out," to me. This is a point that people often seem to ignore amongst all the hate for bonds in general and Total Bond in particular
Nice, my wording says "correlations between all RISK assets approach 1.0. Treasuries and BND for that matter are not in my opinion risk assets. Therefore their correlation with risk assets is far from 1.0 during crisis which is the main reason for holding them. My whole point was the same as yours, i.e. quality bonds like Treasuries of which BND holds a significant amount are the safest port in a severe equity storm and therefore appropriate in a portfolio whether or not they produce significant positive real returns.

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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by grap0013 »

I'm gonna beat this deadhorse one more time. Once again, global equities down ~1% so far today and IEF is +0.13%.
There are no guarantees, only probabilities.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by lee1026 »

Stop beating this dead horse unless if you want me to start posting when they move in the same direction. It is going to happen a lot.

(And I am on your side here!)
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by grap0013 »

lee1026 wrote:Stop beating this dead horse unless if you want me to start posting when they move in the same direction. It is going to happen a lot.

(And I am on your side here!)
:)
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by roflwaffle »

edge wrote:1) I fail to see how a 'Total Bond Index Fund' is 'bad' for a comparison or for use as the bond component of a 60:40 portfolio. Sorry, it sounds silly.

2) VFINX is a (the?) S&P 500 index fund. It is hard to tell but I suppose you are just trolling at this point.

3) In what scenario could a portfolio with 40% nominal bonds be more tax efficient than a 100% total market stock fund? I would love to see the corner case where that occurs. Also, where is this top marginal tax bracket data? It is not in my Shiller spreadsheet...

4) I am not sure why you would calculate treasury yield again, you already have the yield. Maybe you can post your spreadsheet so I can take a look at where you went wrong. The Shiller spreadsheet cannot be used as-is to do the portfolio calculations you are advertising.
VFINX is fine, but if you add another fund (VBMFX in this case) that does worse, then VFINX/VBMFX will also do worse. You can replace VBMFX with sitting on cash and the same idea applies. I agree about taxes, for some reason I thought interest on treasuries was taxed as a capital gain. In that context, whether or not there's a difference depends on state/income levels/etc.. Below ~$200+k (net), I'm guessing there isn't much of a difference for anyone because the higher income taxes on interest can be offset by capital losses. Above that, the taxes on interest would start to add up in some cases. On the other hand, in some states (CA for example), income taxes are high enough that their addition to the federal capital gains tax can result in the same tax rate as the corresponding federal income tax bracket.

I added the yearly top marginal tax rate myself from various sources to see what affect it would have on earnings, and used real treasury yield because I was interested in using the other columns that were already calculated using real values. You can compare 100% to 60%/40% rebalanced annually using nominal values if you want to. :beer
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by grap0013 »

lee1026 wrote:Stop beating this dead horse unless if you want me to start posting when they move in the same direction. It is going to happen a lot.

(And I am on your side here!)
Are you sure you'll get the chance? :beer Global equities all up today and IEF is down -0.27%. 3 for 3 days with negative correlation. Prospective not backtested I might add. Don't take my post too seriously. I'm half joking. I'll zip it and stop being annoying (or funny) depending on your perspective.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by nisiprius »

I'm still not sure I understand Frans' original point.

If people say you can depend on stocks and bond to consistently move in opposite directions, and that they have strong, reliable negative correlation that can be expected to persist in the future, then that's wrong. (Or at least endlessly debatable). And it's not a straw man; it should be, but it isn't. I'm too lazy to compile a list of statements that stocks and bonds "have" negative correlation, but I'm sure I could).

Frans, if you are saying that stocks and bonds do not have reliable low correlation, than that's wrong, too. I don't know of anything that has more reliable, genuinely low correlation. It's much more reliable and much lower--e.g. -0.03--than alleged "low" correlation between e.g. U.S. and international stocks (0.66) or between Fama-French large growth and small value stocks (0.74)

If you are saying that low correlation does not contribute to improving results, that you need negative correlation, that's wrong, too.

If you are saying that low correlation is a weak effect, and may not improve results if the "diversifying" asset has poorer risk-adjusted return than the main asset, then that's true. It's a balancing act between the good effect of low correlation and the bad effect of the diversifier not being a good investment in itself.

I think the case for bonds helping stocks better than most other "correlation stories." Even so... you can tell how much a believer are by whether they choose something like boring old Total Bond, which has low risk, low return, and low correlation... and therefore, because it has low risk = low standard deviation, doesn't do very much to soften the sharp edges of stock volatility... or whether you are one of the people who goes for a long-term Treasury fund in order to get the highest MPT-diversification effect, which I personally think is a fairly bad idea.

If the question is whether someone who wants to be 100% stocks ought to be 90% stocks, 10% bonds in order to benefit from lower correlation, I'd say no, you can gen up statistics to support it but it's a weak case. A much better reason is that 100% stocks is the mark of an enthusiast, and enthusiasm is dangerous... and that if you are 100% stocks because you want Gordon Gekko to admire your greed, you may be one of those people who never gets around to ramping down their stock allocation because you are always waiting for "a good time."
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by livesoft »

Just for fun, here it today's action so far showing that VTI and BND move in opposite directions:

Image
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by nisiprius »

livesoft wrote:Just for fun, here it today's action so far showing that VTI and BND move in opposite directions:

Image
Very impressive. (Not ironic).

I can't leave it at that... the problem even if this is repeatable and reliable, you'd still need to lever up BND by 5X or so for it to be very effective, and while of course that's exactly what experts like Cliff Asness do in funds like QSPIX, it... uh... isn't something I would try to do myself. I think bonds probably do cut the risk of stocks a smidge--whether by negative correlation or by low correlation--but it's so small that it makes more sense to ignore it than to try to figure out whether it's really there (and likely to continue).
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

Well, uh 10 year treasuries did worse than VFINX too. Do you mean VBMFX did worse than 10 year treasuries? If so (haven't checked but probable) then that is simply the luck of the draw OR cherry picking that you selected a high performing sub component of the bond market historically vs. the entire bond market.

I don't think you are thinking about the capital losses correctly. If you did not have to 'waste' them to offset the income from the treasuries you could offset your own income or capital gains or dividends.

I still would like to look at your xls. Please post it. I do not think it is correct or even close. I have put together the spreadsheet myself and it is not showing what you are reporting.
roflwaffle wrote: VFINX is fine, but if you add another fund (VBMFX in this case) that does worse, then VFINX/VBMFX will also do worse. You can replace VBMFX with sitting on cash and the same idea applies. I agree about taxes, for some reason I thought interest on treasuries was taxed as a capital gain. In that context, whether or not there's a difference depends on state/income levels/etc.. Below ~$200+k (net), I'm guessing there isn't much of a difference for anyone because the higher income taxes on interest can be offset by capital losses. Above that, the taxes on interest would start to add up in some cases. On the other hand, in some states (CA for example), income taxes are high enough that their addition to the federal capital gains tax can result in the same tax rate as the corresponding federal income tax bracket.

I added the yearly top marginal tax rate myself from various sources to see what affect it would have on earnings, and used real treasury yield because I was interested in using the other columns that were already calculated using real values. You can compare 100% to 60%/40% rebalanced annually using nominal values if you want to. :beer
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

I am unsure of the context of this statement because of the weird focus on 1 day performance in the chart...but the benefits of bonds cutting risk is obvious in the reduction of volatility in long term portfolios.
nisiprius wrote:I think bonds probably do cut the risk of stocks a smidge--whether by negative correlation or by low correlation--but it's so small that it makes more sense to ignore it than to try to figure out whether it's really there (and likely to continue).
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Frans »

nisiprius wrote:I'm still not sure I understand Frans' original point.
Nis, looking at long-term results with yearly rebalancing, I've shown - with calculations using real-life data rather than complex math - that there is no or no significant correlation between stocks and bonds. It irks me that way too many so-called investment experts throw this claim - that stocks and bonds move in opposite directions and therefore improve returns and lower risk - around as if it's true and well beyond any question.

The, hopefully, well-known curvature in the stocks/bonds risk-return curve has nothing to do with that claim. A mix of any two asset classes with different CAGRs will show this curvature in the risk-return curve, regardless of their STDEVs. That's just a function of combining two independently variable assets. If there is a strong positive or negative correlation, than said risk-return curve will have slightly less or more curvature, but such correlation is not the main reason for the curvature.

It's time this misrepresentation of reality is unmasked as the myth it is.

And now, let's hear it from the naysayers.

And while we are at it, we could start a discussion on rebalancing and the many myths surrounding that subject.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Day9 »

Frans wrote:
nisiprius wrote:I'm still not sure I understand Frans' original point.
Nis, looking at long-term results with yearly rebalancing, I've shown - with calculations using real-life data rather than complex math - that there is no or no significant correlation between stocks and bonds. It irks me that way too many so-called investment experts throw this claim - that stocks and bonds move in opposite directions and therefore improve returns and lower risk - around as if it's true and well beyond any question.
Yes it is frustrating when you see so-called exports propagate falsehoods. Thanks for reminding us that the long term correlation is 0, not negative. But it is still possible for an asset with 0 correlation to improve the expected return/risk of a portfolio. In fact depending on the particulars it is possible for an asset with positive, but less than perfect 1 correlation to do this.

What about the correlation during crises? To an extent don't we only care about negative correlation when stocks fall hard and fast? In 2008 treasuries did really well. But in times of stagflation stocks and bonds both do poorly in real terms.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

Frans wrote: A mix of any two asset classes with different CAGRs will show this curvature in the risk-return curve, regardless of their STDEVs. That's just a function of combining two independently variable assets
This is a very weird statement. First, the whole point of identifying correlation is to see (at least historically) if the asset classes appear to be independent...or not. Second, there is a huge difference in volatility when you have a portfolio of risky assets whose correlation is 1 vs. a portfolio of assets where the correlation is 0.

CAGR is a smoothed number and does not identify the kinds of volatility spikes that drive most individual investors to fail.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Frans »

Day9, As I said, any two randomly varying assets without correlation will result in the risk-return curve. Correlation, positive or negative, will change the curvature a bit.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Frans »

edge wrote:
Frans wrote: A mix of any two asset classes with different CAGRs will show this curvature in the risk-return curve, regardless of their STDEVs. That's just a function of combining two independently variable assets
This is a very weird statement. First, the whole point of identifying correlation is to see (at least historically) if the asset classes appear to be independent...or not. Second, there is a huge difference in volatility when you have a portfolio of risky assets whose correlation is 1 vs. a portfolio of assets where the correlation is 0.

CAGR is a smoothed number and does not identify the kinds of volatility spikes that drive most individual investors to fail.
Weird? Play around with some purely random variables and a spreadsheet and you will see for yourself.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by edge »

I think that is your problem. You playing with random variables but this is not a problem space where that is the appropriate approach.
Frans wrote:
edge wrote:
Frans wrote: A mix of any two asset classes with different CAGRs will show this curvature in the risk-return curve, regardless of their STDEVs. That's just a function of combining two independently variable assets
This is a very weird statement. First, the whole point of identifying correlation is to see (at least historically) if the asset classes appear to be independent...or not. Second, there is a huge difference in volatility when you have a portfolio of risky assets whose correlation is 1 vs. a portfolio of assets where the correlation is 0.

CAGR is a smoothed number and does not identify the kinds of volatility spikes that drive most individual investors to fail.
Weird? Play around with some purely random variables and a spreadsheet and you will see for yourself.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Frans »

edge wrote:...this is not a problem space where that is the appropriate approach.
And the "appropriate approach" is what?
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by nisiprius »

At this point it seems clear to me.

Frans does not dispute that zero correlation can improve results--that a mixture of stocks and bonds can, and probably usually do, have a higher Sharpe ratio than stocks alone. For equal risk, a mixture of stocks and bonds can be reasonably expected to have higher return than a mixture of stocks and cash.

Frans states that it is widely claimed that stocks and bonds "have" negative correlation, and improve results, not just by moving independently, but by moving in opposite directions. This is either a straw man or it isn't. I think it isn't, because I think people really do claim this, probably on the basis that it has been true recently.

Frans states that stocks and bonds have not had negative correlation over the time period covered by SBBI data, and demonstrates this in a novel but valid way.

Stocks and bonds in fact do not have negative correlation over the time period covered by SBBI data.

The only thing to argue about is whether the recent negative correlation is robust, reliable, and can be expected to persist, or whether it's a fluke that can end at any time.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by Frans »

Nis, short-term correlations are all over the place. I have a long-term outlook and ignore short-term phenomena, just like I don't pretend to or are interested in timing the market.
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Re: Stocks and bonds move in opposite directions and improve results? Really?

Post by lee1026 »

The only thing to argue about is whether the recent negative correlation is robust, reliable, and can be expected to persist, or whether it's a fluke that can end at any time.
One thing to consider is that correlations are not prices; there is nothing wrong (in theory) with buying bonds when the correlations are good and selling them when the correlations are bad. Unlike prices, you are not automatically buying when it is high and selling when it is low. And it does seem like that correlation changes last decades at a time.

E.g. If we go for a whole year where the correlation on stocks and bonds are positive when measured on daily data, sell bonds.
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