Correlation Between Yields and Stocks

Apr 27, 2008: 9:40 PM CST

Can the relationship between 10 Year Note Yields and US Stock Prices reveal risk seeking and risk averse behavior of funds and investors?

Earlier, I posted a few charts on the topic, so be sure to refresh with those for more information:

Stock Correlation with the 10 Year Yield

A Look at Bonds, Stocks, and the Fed Rate Cuts

The Bond Market and the Stock Market compete for investor capital, and when certain conditions apply, money will often flow directly from one market into the other, as investors perceive opportunity, or want to control their risk.

While there are a plethora of outside variables that affect these two markets, and there is virtually no way to explain price movements between the two markets perfectly, I did a correlation study between the two markets to see what the correlation resembled over the last few years.

For my test, I compared the weekly S&P 500 prices with the 10 Year Treasury Note Yield ($TNX).

The logic is as follows:

Yield prices are inversely related to bond (or note) prices, meaning when yields rise, bonds are falling. Conversely, when yields are falling, bonds are rising.

While there are many other variables, if investors see the future of the stock market as being ‘too risky,’ or they perceive bond yields high (or some combination thereof), then they will sell some stock and buy bonds (thus driving yields down).

When the stock market is falling, generally people will be exiting the market rapidly and buying bonds, thus seeking safety from falling equity prices. Again, this ‘defensive’ action drives up bond prices and thus decreases yields.

The opposite is true. After the market has fallen for some time and begins rising, and everything seems ‘safe’ again, investors will exit bond positions (driving down prices and causing yields to rise) and buy equities (driving stock prices higher).

Now, for the quick and painless correlation study, I separated the prices and compared them by years and ran a simple correlation analysis in Excel for each year period. Let’s look at the results:

(click on image for larger picture)

What we see is that the correlation is only strong (at least in the last 8 years of price action) during down years in the market.

Here’s a chart of the two markets:

Quick Facts about Correlation:

An “r-value” or correlation is expressed from -1 to 1.

Two series with a correlation of 1 would be 100% correlated (or equal, such that both rise or fall together).

Two series with a correlation of -1 would be 100% negatively correlated (as one rises, the other falls).

Two series with a correlation value of 0 would be not correlated at all.

Typically, anything above 0.50 has a ‘strong positive correlation’ and anything beneath -0.50 has a ‘strong negative correlation.’

In 2002, the S&P and 10-Year Yields were almost fully correlated (they had a value of .91).

2001, another bad year for the market, showed a correlation of .71.

2008 (4 months only) has been a bad year for equity markets, and the correlation has risen to .62 (strong positive yet again).

2006, a relatively good year for the stock market, showed a slightly negative correlation, meaning – for a period – as stock prices rose, bond prices rose too (meaning yields fell). This correlation was not extremely strong, however.

While this is not enough data to draw meaningful conclusions, it does appear that on the surface, yields and stocks correlate in down markets where fearful investors sell their stock positions and buy bonds (driving yields down).

It’s an interesting topic, and one I plan to study more in depth. I’m learning enough about Excel functions to become slightly dangerous!

1 Comment

One Response to “Correlation Between Yields and Stocks”

  1. Swalay Says:

    This Blog is really good and educational. We are pleased to know this blog is really helping other people.