Are Bonds No Longer Safe Assets?... Diverging Views Amid Stock-Bond Synchronization

Correlation Between Stocks and Bonds Turns Positive

"If Synchronization Persists, Investors Will Seek Alternative Safe Assets"

Some Still Argue High-Yield Bonds Remain a Safety Net

As stock and bond prices have begun to move in tandem, the hedging function of bonds against stocks has weakened. Some argue that bonds can no longer serve as safe-haven assets, making it necessary to look for alternative safe assets. However, others maintain that bonds still retain their role as a safe asset.

According to Koscom on May 13, the monthly correlation coefficient between the return on the U.S. S&P 500 Index and the return on the U.S. 10-year Treasury futures price was 0.38 as of February this year. The correlation coefficient had remained negative until it turned positive in February 2022. A negative correlation coefficient means stock and bond prices move in opposite directions, while a positive coefficient means they move in the same direction.

Since 2022, the correlation coefficient between the two returns has turned positive, causing stocks and bonds to move together. Now, when stock prices rise, bond prices also go up, but when stock prices fall, bond prices also decline. This is a departure from the past, when the two returns moved in opposite directions.

This phenomenon is not limited to U.S. Treasuries but also applies to long-term government bonds in the United Kingdom and the Eurozone (the 20 countries that use the euro). John Campbell, professor of economics at Harvard University, focused on bond beta, which shows how closely bond price fluctuations are linked to the stock market. He pointed out, "The average bond beta in the 2010s was -0.2, remaining negative, but it has recently entered positive territory. This is happening in the U.S., the U.K., and the Eurozone alike."

Bonds have traditionally been considered safe-haven assets because bond prices rise when the prices of stocks, which are classified as risk assets, fall. From this perspective, institutional investors could manage risk by including both stocks and bonds in their portfolios, as the two assets would hedge each other.

This hedging strategy is effective only as long as bonds are regarded as safe assets. Professor Campbell said, "If bond beta remains positive, bonds could become as risky as stocks. In that case, investors will sell both stocks and bonds in the event of a stock market decline and look for other safe-haven assets, such as gold or real estate."

As bonds and stocks move together, doubts are being raised about the role of bonds as safe assets. Nam Seokgu, Head of Integrated Asset Management 2 at Korea Investment Corporation (KIC), said, "Given the current environment of high inflation and significant geopolitical risks, the function of bonds as safe assets has weakened, so we need to consider whether bonds will continue to play the role of safe assets in the future. At KIC, we are redefining safe assets and considering including gold, commodities, and hedge funds in this concept."

Son Hyub, Head of Investment Strategy at the National Pension Service (NPS) Fund Management Division, explained, "When supply-driven inflation occurred in 2022, bonds failed to protect against falling stock returns, causing portfolios to become one-sided. Even now, oil prices are rising. When supply-driven inflation hits, the correlation between stocks and bonds rises into positive territory, so we are now examining how to allocate assets and which assets besides bonds can provide diversification effects."

There are still voices asserting that the function of bonds as safe assets remains valid. Seo Joonsik, professor of economics at Soongsil University, said, "Bonds with high yields around 5% still serve as safe assets and can protect returns when stock prices decline. While it is true that in Korea, after a prolonged period of low interest rates, some bonds struggle to maintain a negative correlation with stocks, investors can still prepare for stock market declines through a diversified bond portfolio, including U.S. and Brazilian bonds."

Lee Jaehyung, researcher at Yuanta Securities, commented, "The current phenomenon of stock and bond prices moving in the same direction may be temporary. The synchronization appears to be a special pattern resulting from inflation variables, such as rising oil prices." He added, "If there is a sharp drop in stock prices due to a credit event or a liquidity shock, as in the past, safe-haven demand will strengthen, causing funds to flow back into bonds and pushing up bond prices once again."