Do bonds and stocks generally move together or oppositely?

Question

I've heard that they tend to move in opposite directions, but doesn't inflation bring down both stocks and bonds?

Answer 1

It is my opinion that they tend to move both in the same direction when the direction is dictated by interest rates and inflation. When interest rates rise, bonds and stocks tend to fall in price. When interest rates drop, bonds and stocks tend to rise in price. Same with inflation, but with inflation bonds react more severly than stocks.

On the other hand, when at the end of a bull market ie 2000, bonds tend to move in the opposit direction from stocks. At the end of a bear market the same is true.

Answer 2

Certainly depends on the conditions of the conversion. The Bond did bring in some value at a debt for a reason, the conversion of the bonds to stock can be estimated albeit with some inaccuracy with probabilities much as it is with the Black Scholes equation and the conversion removes a portion of the debt albeit at a value less than the stock being created. However if the conversion occurs, it's most likely because the company is doing well perhaps due to a project funded by the bonds so the conversion simply detracts from the return of that project. Certainly when the bonds are issued, there will be speculation as to the benefit of the project and if the stock holders do not like the projects chances, they will undervalue the stock perhaps selling, a portion will remain neutral and not sell or buy stock whereas a few with resources may buy some stock. I would suspect that there will be a drop in share prices as there's nothing stopping someone from selling their shares but someone in favor of the project may not be in a position to scoop up a bargain so given an equal probability, the stock will tend towards dropping but hopefully the solicitation of debt comes with some consideration and be generally positive to the stockholders but the stocks will not rise in proportion to the enthusiasm. If the terms are structured such that there must be significant improvement in stock value to make the conversion worthwhile then there may not be a drop at all, perhaps a gain but if it's too close to current values then more shareholders will be concerned. Mind you, I don't think NetFlix management made anyone happy in a long long time. Certainly not something easily answered and there are hedge funds based on their internal interpretations of this but I think there will be a slight negative bias simply because fewer bulls will reinvest due to their resources but every bear can sell so the stockholders must generally be in favour of why the bond is being solicited before the stocks can rise. The conversion is really a we'll pay more if we can clause and may get the company a better rate on the bond hence lower risks on the project, some investors will like that.

Answer 3

Generally they move in opposite directions. Because stocks can outpace bonds, bonds are good investment when the market is down, but not when you can get higher return in an up stock market.

You should still have both in you portfolio!

Hope that helps!

Answer 4

They tend to move in the opposite direction, but not completely opposite.
Inflation is bad for bonds, but actually good for stocks.

Answer 5

It depends on which way interest rates are moving. The old saying is "when interest rates are high, stocks will die." This is because bonds/money markets/etc. are percieved as safer investments than stocks, and when the rate of return is high enough, money will start to move into those asset classes to the detriment of stocks. Or so the threory goes. I'm sure there have been intstances when both have moved in tandem, but they really are apples and oranges.

Answer 6

It always amazes me how many uninformed opinions you get in a forum like this.

If you look at returns of the Lehman Brothers Corporate Bond index and regress returns against the returns of the S&P 500, you will get a coefficient of about 0.25. This means that the corporate bond market has a beta of about 0.25, Positive betas mean positive correlation. This means that the move together more often than they move in opposite directions. I have actually done this analysis for presentation to my former students at Berkeley and Wharton.

That being said -- there are plenty of times when they move in opposite directions.

Let's examine what is going on. Suppose that interest rates go up -- but everything else stays the same (meaning that projected earnings of companies do not change). Now -- let's examine what happens to 1. Long term bond indices, 2. Short term bond indices, 3. Growth companies, 4. Mature companies.

1. Long terms bonds lose value when rates go up. Even though coupons can be reinvested at a higher rate, the principal loss is usually greater, so long term bond indices lose value.

2. Short term bonds don't really lose much value when rates go down. In addition, money will be returned quickly and reinvested in higher rates, so total returns on short term bond indices go up when rates increase.

3. Growth companies do not have positive cash flows for a while. Increasing rates means that the discount rate for these companies increases -- causing them to lose a lot of value -- and moving in the same direction as the bond market

4. Mature companies have more cash flows coming sooner. These also get discounted at a higher rate -- but the value of the company is not generally affected too much.

When rates decline, the opposite will hold.

There is one other interesting thing that affects growth firms. If rates increase, it may cause them to invest less in the company -- and when they go down it may cause them to invest more in the company. Why? Because if rates go down it makes projects cheaper to fund. And if you make a project cheaper, its net present value increases. This increases the relationship between returns of growth companies and long duration bonds.

If the yield curve steepens, you could actually have an effect that is bad for growth stocks and good for value stocks.

So far, I've talked about the effect of interest rates on equity returns. But consider the effect of equity returns on bond yield's. Let's suppose that treasury rates don't move at all -- but a company's stock increases in value. The fact that the company is worth more means that the credit quality of their bonds increases. This this happens, the value of their bonds must also increase -- so their bond yields drop. In this situation, equity and bonds move in the same direction.

Answer 7

Inflation makes bonds drop and stocks get choppy or go down.Deflation(2000-2002)is great for bonds and kills stocks.

Answer 8

I cannot improve upon Morlock's answer.