Earlier this year, Richard Bernstein put out an interesting graphic that shows the historical correlation of various asset classes relative to the S&P 500 over the 35-year period ending in December, 2015:
What’s interesting in this graphic is that both long-term Treasurys and intermediate Treasurys have essentially the same negative correlation to the S&P 500 despite intermediate Treasurys registering close to neutral on the beta scale.
This may come as a surprise to some people who have come to think of bonds as essentially risk-free instruments, despite the fact that interest rates have been in a secular decline (bond prices move inversely to rates) over the period that Bernstein observed. In fact, going back to the end of 1996, when the 30-year Treasury bond yielded around 7%, the Barclays 30-year Treasury Index has demonstrated volatility (as measured by standard deviation) of 13.2%, which is about 86% of the S&P 500’s volatility over the same period, and almost 240% of the Barclays 5-10 year Treasury Index:
Basically, over the last ~20 years, investors in long-term Treasurys have been taking on roughly stock-like volatility in exchange for an incrementally higher total return, and for actually a bit less diversification benefit than owning much less volatile intermediate Treasurys. Graphically, the relationships look like this (December 1996 – October 2016):
What current investors must keep in mind is that, as Ben Carlson pointed out, the outperformance of long-term Treasurys over the last few decades can largely be attributed to much higher starting yields due to the inflationary pressures that pushed rates higher in the late 1970s and early 1980s. With current yields on the 30-year Treasury bond around 3%, investors in long-term Treasurys are likely to experience a much more volatile ride, given that the duration (that is, sensitivity to interest rate movements) on the 30-year bond is more than twice what it is for the 10-year.
It shouldn’t be surprising that long-term Treasurys exhibit almost the same degree of volatility as equities. After all, as we discussed in A Better Way to Think of Cash, Bonds, and Stocks, stocks are essentially high-duration instruments, or perpetuities. The further out on the duration scale you go with bonds, the more likely they will behave like equities, even if they are of the highest equality:
For further reading on equity duration (and thanks to Tadas Viskanta for these links):
The Impact of Equities In Pension Investing: It’s Not Just Return – Vanguard
Equity Duration of the S&P 500 – Standard & Poor’s
Disclosure: The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
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