23Nov21
Hey guys! Hope you're doing well, it's been a while. Today, on 23rd November, 2021, we will be doing a quick macro analysis on Bonds and the effect on Index performance. I have a suspicion that the recent Fed announcement of dialing back purchases on Treasuries will lead to an uptick in nominal interest rates, thus a small decline in SP500 Index growth (in basis points). As a bonus, i'll be also doing a DCF analysis of Nvidia in the near future, so keep an eye out.
The PIMCO Study Summarized
The research conducted in 2013 by PIMCO can be summarized as follows: (1) Short term negative correlations between stock growth and bond growth can be observed. Meaning that generally, in the short term, if stocks fall, bonds rise. This has also confirmed my observations in intraday movements on VOO (a SP500-like ETF) and TLH (a Midterm ishare treasury bond ETF). (2) The negative beta between stocks and inflation may become less pronounced over longer horizons. From what I gather, the relationship between inflation and stock price growth is not immediately clear, as many have pointed out that the tremendous rise in Index value can be largely attributed to Fed Powell’s monetary policies, i.e. money printer go “BRRR”, and would seem to indicate that high inflation levels had indeed correlated positively with a high index. Even so, however, we must still be cautious as this assumption of continuous growth can only last up to a certain point. This inflation-driven ‘euphoria’ can only be sustained until the general market deems the inflation level at peak is severely imbalanced to the extent that the effects of a prolonged widened economic imbalance outweighs the nominal index basis point growth.
Since 2008, ST correlation (between stocks and bonds) has been negative. The ‘million dollar’ question PIMCO aims to answer is this: “Will higher interest rates or rising inflation in the future make the correlation less negative?” Thus, the majority of their research focuses on discovering whether a correlative relationship can be observed between four macroeconomic factors: real interest rates, inflation, unemployment and growth. Furthermore, to what extent can these relationships continue to be relied upon to make inference and predictions for future Index movements?
Practical Solution going forward
Stock-bond still provides a nice way to strategically allocate assets. However, if inflation volatility is predicted to (or show signs of) increases significantly, then the correlation between stocks and bonds can reverse from negative to positive, thus the quantitative strategies that hold this underlying assumption will have to be look at more carefully from here on out.
