U.S. stocks and bonds return to negative correlation! Safe-haven assets are in demand, with U.S. bonds returning to a "defensive position."

With a large number of investors pouring into bonds, it is a victory for fund managers who have been advocating for bonds - and broader asset diversification - for many years. This has been a long-standing unpopular suggestion. It wasn't until this month when the stock market began to decline, leading to a rapid surge in the demand for bond safe-havens, which briefly pushed the yield on the 10-year US Treasury to its lowest level since mid-2023.

This rebound has caught many on Wall Street by surprise. The long-standing relationship between stocks and bonds - where fixed income rises to offset losses in a stock market crash - has been questioned in recent years. Especially in 2022, this correlation completely collapsed as bonds failed to provide any protection during stock market declines. (In fact, US Treasuries experienced their most severe losses on record that year.)

However, despite the sell-off at that time being triggered by an outbreak of inflation and the Federal Reserve's attempt to curb inflation by raising rates, the recent stock market plunge has been largely driven by concerns about the economy entering a recession. As a result, expectations of rate cuts quickly heated up, and bonds performed very well in this environment.

While the S&P 500 index fell by about 6% in the first three trading days of August, the US bond market rose by nearly 2%. This meant that investors who allocated 60% of their assets to stocks and 40% to bonds (a long-standing strategy to build a diversified portfolio with lower volatility) outperformed those who held only stocks.

As the stock market stabilizes in the past few days, bonds will eventually erase most of their gains, but the broader view - fixed income acting as a hedge in times of market turmoil - still holds.

George Curtis, portfolio manager at TwentyFour Asset Management, said: "We have been buying government bonds. This is a hedge." In fact, Curtis started increasing his holdings of US Treasuries months ago - partly because US Treasury yields are now higher, and partly because he also expects the old stock-bond relationship to return as inflation subsides.

Negative correlation between US stocks and bonds is returning

From another perspective, the traditional inverse relationship between these two asset classes - which was basically the case in the early decades of this century - is back, at least for now.

Last week, the one-month negative correlation between stocks and bonds reached its highest level since the regional bank crisis last year. A reading of 1 indicates that assets move completely in sync, while -1 indicates they move completely in opposite directions. A year ago, the index exceeded 0.8, the highest level since 1996, indicating that bonds as a portfolio "ballast" were actually useless.

As the Federal Reserve's aggressive rate hikes starting from March 2022 led to two market crashes, this relationship underwent a dramatic change. The so-called 60/40 portfolio lost 17% that year, marking its worst performance since the 2008 global financial crisis.

![dd162bfc44089020cb0e03bedff201f.png](https://img.zhitongcaijing.com/image/20240812/1723420165744790.png? Now, the market background has shifted back in favor of the bond market, with inflation under more control. The market focus is turning to the possibility of a recession in the United States, while U.S. Treasury yields remain well above the 5-year average level.

In the coming week, investors bullish on bonds will face significant risks. The U.S. CPI and PPI reports for July are about to be released, and any signs of inflation resurgence could push yields higher. This Thursday, after an unexpected drop in weekly initial jobless claims, yields have already started to rise, easing concerns about a weakening labor market. With escalating worries about an economic recession, this data suddenly caught people's attention.

Despite the excitement in the bond market today, there are still many cautious voices like Bill Eigen, a bond fund manager at Morgan Stanley.

Eigen manages the $10 billion JPMorgan Strategic Income Opportunities Fund. Over the past few years, over half of the funds he manages have been in cash, mainly invested in U.S. Treasuries and cash equivalents like money market funds. The yield on U.S. short-term Treasuries is only slightly above 5%, at least a full percentage point higher than long-term bonds. Eigen does not believe that inflation is truly mild enough, nor does he believe that the economy is weak enough to warrant the Fed taking easing measures to change the situation.

He said, "The rate cut will be small and gradual. The biggest problem facing bonds as a hedge tool is that we are still in an inflationary environment."

However, Bloomberg strategists Ira F. Jersey and Will Hoffman said, "During a recession, the yield curve tends to steepen. On August 5, the U.S. 2-year/10-year Treasury yield curve briefly inverted, possibly signaling a steeper trend in the bond bull market. We expect this trend to continue as the economy slows down. At the same time, we believe that the correlation between stocks and bonds may be normalizing."

More and more investors, like Curtis, are placing less emphasis on inflation. During the most volatile market fluctuations last week, bond investors sent a brief message that their concerns about economic growth are becoming alarming. For the first time in two years, the yield on U.S. 2-year Treasuries fell below the yield on U.S. 10-year Treasuries, indicating that the market is preparing for a recession and rapid rate cuts.

Pacific Investment Management Company's Chief Investment Officer Daniel Ivascyn said, "With declining inflation and a more balanced risk, and even a bias towards concerns about economic slowdown, we do believe that the bond market will exhibit more defensive characteristics." "