To hell with the rules! At least that is what the financial markets say.
It does not matter how involved in finance you are; rules can, should, and must be implemented. Assuming you want to be successful.
Diversification, measuring risk, determining profit targets and knowing when one has made a mistake. These are only a few of the things investors need to be aware of and consider.
One of the larger overarching rules of the financial markets revolves around how equities and bonds interact. Generally speaking they have an inverse relationship. Meaning, when one goes higher in price, the other should go lower.
Why does this happen?
For simplicity, this inverse relationship happens because investors are always weighing how much safety they want versus how much return they want to try to attain.
Bonds by nature lean toward the safest part of the spectrum. They are contracts between the bond issuer and the buyer. All the terms are laid out beforehand and you know how much you are going to get paid and when. Because of this predetermined nature of the contract, you go into the investment with a confident approach - a.k.a. safety. You can check out our bond primer
to learn all the gory details.
When you buy stock in a company, you are buying a piece of the company, so you are along for the ride. Good, bad or indifferent.
When the economic landscape appears to be on a sure footing and investors believe growth is going to happen. i.e. stock prices can rise. They sell their “safe” bonds to get money to buy stocks.
When the economic landscape appears to be on shaky ground and investors believe growth is going to slow then stocks prices can go lower. They take profits on their stock positions and buy the “safety” of bonds.
This movement of investor money between stocks and bonds is called rotation.
Rotation happens consistently over time and is something market participants always keep and eye on. If you can pinpoint when the switches may take place you can enter into those investments before the herd changes direction. Hello profits!
But what if the expected rotation is interrupted or stops?
For the rotation to stop it is generally because of an unexpected large force entering the market. In COVID times this is currently happening because of the role the US Federal Reserve is playing in the markets
Thanks to COVID and global economic uncertainty, the US Federal Reserve is keeping bond prices stable by purchasing them in massive quantities. This is affecting the bond market and keeping the before mentioned rotation from happening naturally. If you want to get into the details of what the US Federal Reserve is buying you can read our November newsletter post here
To illustrate how the normal rotation is currently NOT happening let’s look at a few charts.
The S&P 500 has been on an absolute tear since the lowest point of COVID terror in March. It is easy to see how the price of the index has moved in a swift up and to the right direction.