The Two-Year Trend Has Reversed... Bonds Are Back

Stocks generally outperform bonds...

This isn't a hard concept to understand. More risk means more return – and stocks are much riskier than bonds.

But it's really about when you'll need your money.

See, stocks are the only asset class that has beaten inflation in every 20-year period over the past 100 years. So the longer you plan to be invested for, the more you should lean toward equities.

Bonds are more for short-term financial needs... like money you'll want in the next two to five years. Since bonds are less volatile than stocks, they make for much safer investments in the near term.

While this limits their upside potential, it's also why bonds are often used as a "hedge" against falling stock prices.

Historically, bonds and stocks have had a negative correlation – meaning bond prices rise when stocks fall, and vice versa.

However, this relationship has broken down since early 2022. When the Federal Reserve started raising interest rates, both stock and bond prices declined simultaneously.

Normally, if the government or corporations offered higher rates, it would attract risk-averse investors. But if bonds weren't going to act defensive, investors weren't interested. As we'll explain today, that's all changing...

In the first three trading days of August, investors witnessed a market bloodbath...

The S&P 500 Index fell 7% due to weak manufacturing activity and rising unemployment data. The Nasdaq Composite Index slid more than 10%.

Meanwhile, demand for bonds went up. The U.S. Treasury market saw gains of around 2% over the same span.

In other words, the trend we've seen in the relationship between bond and stock prices over the past couple years is reversing.

As was the case before the Fed started its rate-hiking campaign, bonds are once again seen as a hedge against stock volatility.

According to Bloomberg, between 2000 and 2021, the correlation between stocks and bonds was negative.

It flipped to positive in 2022, when higher rates caused both bonds and stocks to crater. And it had stayed that way until last month... when it went back to negative.

This signaled that bonds are returning to their typical market role as a way to offset losses from stocks.

It's also a sign that investors are growing increasingly worried about a potential recession...

And they're not entirely wrong to be concerned.

Last month, the economy triggered the Sahm Rule with worse-than-expected unemployment data.

The unemployment rate jumped to a three-year high of 4.3%, and job growth slowed.

Now, as we covered yesterday, it's important to determine whether unemployment data is "good" or "bad" by looking at weekly initial claims.

Initial jobless claims came in lower than expected, so the situation isn't as dire as it seems.

All macro-related data is under a spotlight today – especially jobs data, as we discussed a few weeks ago. And right now, we're dealing with a mixed bag of results.

In this uncertain environment, investors want to protect their hard-earned money. And bonds are an attractive option for them, as they've regained their hedging power against stocks.

This could lead to a surge in demand for both corporate and government bonds.

It won't be long before interest rates are brought down from their two-decade high...

A week from today, the Fed will have its September policy meeting. And it's sure to announce the first interest-rate cut to aid the economy.

It's only a matter of how big that cut will be... Whether the federal-funds rate is lowered by 25 basis points or 50, we can't be sure.

Either way, recession-fearing folks are likely to start buying bonds to protect their investments. Now that the trend of the past two years has reversed, it's the perfect place to park their cash.

Meanwhile, savvy investors have a chance to get into the bond market early and lock in high-yielding bonds before their prices start rising.

Regards,

Rob Spivey
September 11, 2024

P.S. There's huge opportunity in the bond market today – especially when stocks are scaring people away with their constant ups and downs. Equity investors simply won't find the level of near-certainty that they will with bonds.

It's why billionaires like Warren Buffett and Howard Marks turn to the bond market in times of crisis. That said, you don't need to be a legendary investor to take advantage of the current market setup.

If you're new to bonds, I urge you to check out our Credit Cashflow Investor monthly advisory. Each month, the Altimetry team and I recommend a low-risk corporate bond that's trading for far less than it should be (and yielding far more). And we break down each opportunity in easy-to-understand terms. To learn more and get started in the bond market, click here.