Munich, Germany
Experience: Advanced
Platform: Sierra Chart
Broker: Interactive Brokers
Trading: liquid products
Posts: 570 since Jul 2016
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The correlations vary dramatically, and don't readily lend themselves to mean-reversion or correlation-based trading strategies. Oftentimes there are strong opposing forces in play that throw the correlations off completely.
A few general rules:
Broad economic growth is good for stocks, but often bad for bonds, because with growth often comes the risk of inflation which reduces the present value of future principal and interest payments. If, for example, the monthly employment report soundly beats expectations, you can expect stocks to rally and bonds to sell off, because a strengthening job market means consumers will have more income to spend on goods and services, allowing companies to raise prices and increase profits, making fixed-rate, longer duration bonds a much less attractive investment. This suggests negative correlation (stocks up, bonds down).
Increased uncertainty regarding the economic outlook translates to higher risk for investors. This, typically, leads to increased volatility, which makes the expected risk-adjusted returns of bonds more attractive than stocks. This scenario creates the "safe-haven" bid we often hear about in the bond markets. This, again, suggests negative correlation (stocks down, bonds up).
Rising interest rates (falling bond prices), can be bad for stocks, especially those of companies with large amounts of debt, because their financing costs will increase, thus exerting downward pressure on profit margins. Also, rising inflation reduces the present value of not only future principal and interest payments from bonds, but also future dividend payments from stocks. This suggests positive correlation (bonds down, stocks down).
Increasing broad market liquidity, the proverbail rising tide, can lift all asset classes. Aggressive debt monetization, for example, floods the markets with cash, pushing prices of stocks, bonds, and commodities higher all at once. Conversely, when liquidity conditions tighten and money flows out of the system, stock and bond prices can both go down together. This suggests positive correlation.
When you plot the stock / bond correlations over longer periods you will see that they frequently revert back and forth from positive to negative depending largely on the broader themes impacting financial markets over these time periods.
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