We’ve noticed a troubling phenomenon under the surface of the global markets. Starting just a matter of weeks ago, there was a violent shift in short-term asset class correlations. Whereas in the past, U.S. bonds could be counted on to soften the blow of an equities market downturn, we’re now seeing an unwelcomed situation, one in which stocks AND bonds fall simultaneously.
Below is a chart showing the Four Horsemen: U.S. Stocks, International Stocks, U.S. Treasuries, and U.S. Corporate Bonds. Most of the time, the two bond categories are not highly correlated to stocks and are a good diversification tool. Unless bonds find much needed buyers again soon, we may be in for a time of highly correlated stocks and bonds, which won’t be fun if they continue to fall together.
(Source: Yahoo Finance to 6/24/2013)
Matter of fact, one has to venture back over 30 years ago to find a multiple month time period when all four asset classes fell in unison. It was during the final stage of the bond bear market (yes, even bonds have bear markets) back in 1981. All four asset classes fell double-digits, although the pain wasn’t as great as when three of the four fell together during the 2008 financial crisis. At that time, U.S. Treasuries soared in a bid for safety, which was a welcomed development, one we are not (so far) enjoying in the present.
What fate does the future hold?
In a recent interview, Jeffrey Gundlach from DoubleLine Funds seemed to imply that this back-up in yields has nearly exhausted itself and will peter out somewhere between here and 2.90% on the 10-year Treasury. We see strong arguments for both sides of the issue. We believe most of the arguments for the continued implosion of bond markets around the globe, but we also see strong signs of a global economic slowdown. These two forces seem to be in a violent tug-of-war that until settled, only brings one certainty: volatility.
Fortunately, a few of our tactical strategies have benefited from a rise in bond yields (via an inverse ETF) for several weeks now. Our models will stay with that trade as long as the trend continues. Always seeking new opportunities, our tactical strategies will continue to monitor the rapidly changing investment climate, looking to take advantage of new trends as they emerge.
Steve K. Rumsey
Chief Investment Officer
Optimus Advisory Group