In addition to giving most of us a badly needed wake-up call from the market complacency that had set in, the sell-off of a few weeks ago was unique in two ways.
The market dropped faster than most of us have ever witnessed. In fact, it was the biggest point drop in a single day in the Dow’s history.
But what was even more unusual than the size and speed of the sell-off was that bonds – Treasurys in particular – sold off with stocks.
Most of us have heard the phrase “flight to safety.” It means that when the fear-greed gauge (the Volatility Index) swings heavily to the fear side, we tend to move to the safety of bonds.
Declining Treasury yields and increasing bond prices are the usual measure of the shift to safety and lower-volatility holdings.
If the rule states we buy bonds when stocks drop, then bonds and stocks should not move up or down in price at the same time. It should be an inverse relationship.
The fact that bonds and stocks have been moving up at the same time for almost eight years should have been an indication that this sell-off would be different. But the markets appeared to be stunned by the move.
The point here is that despite what happened in mid-February, in 87.6% of sell-off cases since 1929, intermediate bonds and the 10-year have moved in the opposite direction of stocks. Bonds have increased in price when stocks have fallen.
Yes, even when the 10-year’s yield was within 0.5% of the low 2.9% yield we now have, the “flight to safety” rule functioned normally 87.6% of the time.
Here’s why you should be paying attention to this relationship.
As we age, we have to be more protective of our money. That means that in addition to lowering the overall risk of our holdings, we need to hedge the stock portion of our portfolios by balancing with bonds.
Whether they’re government-guaranteed, tax-free or corporate bonds, diversifying into bonds provides the lower volatility needed in a sell-off to prevent the average guy from panic selling.
Don’t kid yourself – almost all of the losses the average guy incurs are a result of panic selling when he sees his account value dropping.
Bonds move up in price when stocks drop. The flight to safety and the increasing value of bonds will provide the sense of security (stable account value) that we need to turn the other cheek and not click on that sell button.
Selling in a panic at bargain basement prices benefits only the guy who’s buying at the bottom.
Going forward, volatility is the name of the game. If you expect to survive this market, you’d better find a way to keep your fear reaction in check and stay in your holdings. For us over-50 guys and gals, hedging with bonds is the answer.
Next week we’ll talk about how much of your holdings should be in bonds.