Whether Bonds and Stocks are Correlated Depends on the Timeframe

In the short-term stocks and bonds have again turned anti-correlated after a period of positive correlation, in the medium-term they show no correlation and in the longer-term they are anti-correlated.  Correlation depends on timeframe.

This is nothing new: correlation, such as volatility and expectation, depends on the timeframe. There are no absolutes here in the same way that in modern physics any measurements made by an observer depend on relative state of motion. In the markets, any parameters calculated by a trader depend on timeframe. This is one reason – but not the only one – that traders should be careful when evaluating signals from different timeframes.

SPY_TLT_CORR_20150505

As is may be seen from the first indicator pane in the above chart, the zero lag, 20-day correlation between SPY and TLT has again turned negative after rising in February to peak near +0.40 in April.

The medium term correlation (zero lag, 60-day) shown in the second pane steadily increased since February from negative levels towards zero. In the medium-term, bonds and stocks are not correlated. Does this mean anything? Probably it doesn’t mean much.

The longer-term zero lag, 120-day correlation has stayed flat since April near -0.40. Does this help portfolio allocation? I don’t think so. It could fall or rise from here. If both stocks and bonds correct, as some fund managers believe (Bill Gross is one of them) then the correlation will rise and investors will lose both ways. Diversified portfolios already feel the heat from the rise in correlation.

Anyone expecting to find gold in correlation studies will be disappointed. Profits in the markets are “absolute” but indicators, such as correlation, are relative to frame of reference.  Maintaining consistency in analyzing the markets is a key. Mixing time-frames can lead to confusion.

You can subscribe here to notifications of new posts by email.

Disclosure: no relevant positions.
Charting program: Amibroker
Disclaimer

© 2015 Michael Harris. All Rights Reserved. We grant a revocable permission to create a hyperlink to this blog subject to certain terms and conditions. Any unauthorized copy, reproduction, distribution, publication, display, modification, or transmission of any part of this blog is strictly prohibited without prior written permission. 

This entry was posted in Quantitative trading, Technical Analysis and tagged , . Bookmark the permalink.