A popular diversification pitch is that “when stocks go down, bonds go up, and vice versa, so it pays to hold both.” But it simply is not so. The relationship between stocks and bonds is more complex and does not always lend itself to generalizations. The bond market is too large and comprises too many different types of bonds to be viewed as a whole.
Stocks Down, Treasuries Up
When institutions sell stocks, they seek a safe place to park the cash, such as short-term Treasury securities, which typically go up when stocks sell off.
Bonds Down, Stocks Down
When interest rates rise, both stocks and bonds go down because inflation is generally considered bad for both stocks and bonds. Investors sell both, seeking safety in cash or gold.
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No or Limited Correlation
Stocks generally decline when the economy goes into a recession. Interest rates typically fall in a recession, which is generally bullish for bonds, so they should rise. However, a recession may be bad for high-yield bonds whose issuers may not be able to make interest payments in an economic downturn, so high-yield bonds decline.
State tax receipts also decline in a recession, raising fears of default in lower-quality municipal bonds, so those can decline too. On the other hand, U.S. Government debt and high-quality bonds issued by blue-chip companies are considered safe havens in a recession and may rise.
- pen showing diagram on financial report/magazine image by Anton Gvozdikov from Fotolia.com