Swedroe: Gurus Trip Over Bond/Stock Correlation

June 15, 2015

A good number of Wall Street “gurus” have, for quite some time now, been loudly and repeatedly warning investors that bond yields will soar. That, they caution, will in turn lead to falling stock prices.

 

Unfortunately, this bit of “conventional wisdom” regarding the relationship between stocks and bonds may have led many investors to panic and abandon even well-thought-out financial plans.

 

So far this year, the market’s actual results provide yet another example of why investors are best served by following Warren Buffett’s sage advice: Ignore all market forecasts because they tell you nothing about the market, although they do tell you a lot about the person making the prediction.

 

Higher Bond Yield, Higher Stocks

The yield on 10-year Treasuries reached its lowest closing level of the year, 1.68 percent, on Jan. 30. On June 10, 10-year Treasuries closed at 2.50 percent, an increase of 0.82 percentage points. That’s quite a rise in just over four months.

 

Defying many of the so-called experts, the S&P 500 Index rose 120 points from its close of 1,995 on Jan. 30 to its close of 2,105 on June 10.

 

That’s a price-only increase of 6.0 percent, not a bad return for just more than four months, especially if the alternative was the 0.0 percent return on Treasury bills.

 

Conventional Wisdom Wrong

Despite the aforementioned conventional wisdom, from 1977 through 2014, the annual correlation between the term premium and the U.S. equity premium has actually been slightly negative, at -0.12.

 

That means when bond returns have been below average (as has been the case in the first part of this year) there has been a slight tendency for the equity premium to be above average (which has also been the case in the first part of this year).

 

Use this lesson as a reminder that even the most pervasive pieces of “conventional wisdom” can be wrong.

 

Doing so just might help you avoid making the mistake next time of paying attention to some guru’s forecast.


Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

 

 

 

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