Today, we will speak of stocks and bonds, and their notorious relationship. We will also speak of the election that threw that relationship into turmoil and attempt to understand their recent, mystifying behavior. To understand where all of this might be headed, we will need to think carefully about things that might happen in the Trump presidency. That should be fun too, for he is fascinating.
The relationship between stock prices and bond prices has been endlessly analyzed, as they almost always correlate, but the correlation can be positive or negative. In general, their relative prices tend to head in opposite directions over the short term, while moving together over the long-term. This relationship is not only mathematically permissible, but pretty simple to grasp. If you want a visual, make a time vs. price chart and draw a wavy double-helix moving across it from side to side.
Negative correlations are triggered by changes in global economic confidence. When traders see good times ahead, they sell bonds for the upside potential of stocks, while when traders see danger ahead, they sell stocks for the safety of bonds. Positive correlations depend on long-term investor health and a host of outside factors. One example: in the Spring of 1995, the global economy, moving from early 1990’s recession toward late 1990’s boom, hit the sweet spot on the curve, and interest rates—as well as inflation and unemployment—began to tumble. Every time global rates fell, existing bonds, written at higher rates, became more valuable, so bond prices went up. A lot of traders took profits on bonds, then saw that compared to the bond market, stocks were cheap, so they put their new money in stock. As it was the beginning of the internet boom, things worked out pretty well for most of them, as long as they figured out early on that Netscape never stood a chance against Microsoft (MSFT).
The point is that with stocks and bonds, even apparently contradictory relationships are easily explained. What can’t be easily explained, is what happened last week.