Bonds No Longer Work to Diversify Stock Risk, Credit Suisse Says
(Bloomberg) -- Investors can no longer rely on bonds to help mitigate equity risk because the relationship between assets has broken down, according to Credit Suisse Group AG.
The 21-day correlation between the S&P 500 Index and 10-year Treasury yield turned negative on Aug. 21, after having been at nearly 0.80 in mid-July.
“The breakdown in that correlation, alongside record low rate volatility, suggests bonds are no longer an effective diversifier of equity risk,” Mandy Xu, derivatives strategist, wrote in a note dated Aug. 24. “We recommend investors look at equity-specific hedges instead, especially with the normalization in equity volatility.”
The ICE BofA MOVE Index, which measures volatility in Treasury options, hit a record low on July 30 as the Federal Reserve continues to provide support to the economy and has signaled that interest rates will probably remain at or near zero for years.
On the other hand, the Cboe Volatility Index, or VIX, remains elevated, though well off its peak levels of above 80 in March. It closed at 22.37 on Aug. 24, versus a lifetime mean of about 19.4. That’s as stocks rally to records despite the uncertainty about the public-health and economic effects of the coronavirus pandemic.
Xu suggested trades like put-option spreads to hedge in the current environment.
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