Anti-Correlation Between Stocks and Bonds is Still High

The 12o-day rolling correlation between stocks and bonds made a low of -0.81 during February of 2012 and since then its has risen to slightly higher levels around -0.66. However, the correlation is still low and despite the correction due to a rise of both stocks and bonds during 2012, currently the tendency is for a fall to lower levels. If stocks and bonds remain anti-correlated, then this means that soon they will move in different paths. This further means that either stock investors or bond investors will profit but not both.

This is inevitable because at the end of the day medium-term investing and trading are mostly a zero-sum game unless there is creation of new wealth. When trading or investing in such environments one is actually waiting for someone else to make a mistake and lose money. I have written about these realities of the market in my out-of-print book Profitability and Systematic Trading. I am sorry I did not hype trading and investing in that book. I chose to expose some of the misconceptions about this game from a both fundamental and technical perspective. Apparently, some did not like that. However, if I ever revise the book content and publish it again I will expand on those issues.

SPY_TLT_20130328

The top pane show a daily chart of TLT since inception and the middle pane shows the corresponding prices for SPY. The bottom chart is a graph of the rolling 120-day correlation between the two. It may be seen that the correlation made a bottom during February of 2012, then rose slightly and remained flat until November at around the same value where it is currently, close to -0.66.

The mean rolling 120-day correlation between SPY and TLT since inception of the latter is around -0.35.  It is quite unlikely to see in the near future conditions for a positive correlation like during 2004 and 2005 where both stocks and bond rose. There was a lot of artificial wealth created then through derivatives that led to the credit bubble and its eventual burst in 2008. Now, wealth is fixed with a tendency of being destroyed, i.e. there are stil deflationary presures. As a result, the game is zero-sum or even negative-sum. Either bond funds or stock funds will profit under current conditions but not both. This may change but I do not see a prospect for that in the near future.  Success will depend this year on proper allocation and on quality of macroeconomic or technical forecast. Things may turn around fast and stock investors may find their gains disappearing while bond fund investors may see profits again like in 2011. This is a game of probability and dealing with it successfully is both of an art and a science.

Disclosure: no relevant positions at the time of this post

Charting program: Amibroker (Charts created with AmiBroker – advanced charting and technical analysis software. http://www.amibroker.com/”)

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