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Stocks-Bonds Correlation Reversal

What is the reason the correlation between stocks and bonds has turned negative after about 2000? Is there an explanation for that? In this article I claim that this question has no clear answer.

As it may be seen below, the correlation between continuous U.S. T-Bond and S&P 500 futures was significantly positive from about 1984 to 1998 but then turned significantly negative after about 2000.

What caused the correlation sign reversal after 2000? There is an answer to that: We do not know. Anyone who thinks has the answer is overestimating their analytical skills and understanding of markets.

The reason we don’t know is the following: Markets are highly complex non-linear stochastic processes. There is no way to establish the significance of any cause in the case of such systems. Things just happen. Every attempt to attribute causes to market action only tells part of the story due to complexity.

For example, I can assume reflexivity played a role. Since Treasuries are guaranteed by the U.S. government, during the dot com bear market, investors sold stocks and bought bonds. As a result, bonds gained while stocks were falling and this caused the anti-correlation. This is shown in the above chart by the first gray area.

Then, during the financial crisis bear markets, investors again sold stocks and bought bonds.  Maybe because this worked before? This is shown by the second gray area. So now why have the following puzzle:

Did the actions of investors caused the negative correlation or the negative correlation caused the investor actions?

We cannot answer the above question because we do not know if bonds and stocks were structurally anti-correlated after 2000 because of economic reasons or the investor actions caused the anti-correlation.

Therefore, we cannot answer the question about what caused the correlation reversal. It is what it is. And will remain as is, until it changes. Because at some point in time investors may not believe that bonds are a good hedge against stock declines. No one knows what will happen. Yields may even go negative in U.S. or spike due to inflation pressures. We cannot know the answers and this is why traders take markets one day at a time.

Charting and backtesting program: Amibroker

Data provider: Norgate Data

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