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On Stocks and Bonds

May 22, 2011

In our last post we discussed the benefits of  a simple long stock portfolio with a levered bond position, and how the combined portfolio had lower drawdowns than just being long stocks.  Deciding to look further under the hood, we were curious what the exact stock/bond return breakdown was during months where stocks fell by more than 2 standard deviations, going back to 1987.

As it turns out, the S&P return component totally dominates the overall portfolio performance, apparently because stocks are a lot more volatile than bonds.  Another way to visualize this is to look at the 12 month rolling correlation between the “just stocks” portfolio and the “stocks + levered bonds” portfolio.

All of this begs the question: why a mix of stocks and bonds in the first place? The whole idea of the combined portfolio, often in a 60/40  allocation, is one of the most common practices on Wall Street. But does it necessarily make sense? There are several ways to approach this question, and as a starting point we’d like to offer the following chart of the rolling 12 month correlation between the S&P 500 and US Treasuries.

Categories: bonds, hedging, stocks
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