Do Treasuries Still Have a Place in the Diversified Portfolio?
The treasury bond market is a mess. I don’t mean that it isn’t functioning, I mean that the trends in these haven assets are as ugly as I have seen in a while. This brought out an interesting question on a call that I was on last night:
“With treasuries in a downtrend, what do you do if you are trying to run a diversified portfolio?”
It is an interesting question, but the answer may be more surprising, at least in my opinion…you own treasuries.
Ok, let me back it up. Diversification is a risk mitigation / risk management tool. The goal of it is to own a basket of assets so that when one group zigs, the other zags. This should, in theory offer a level of protection to the overall portfolio. The trade-off is lower returns vs owning 100% of a riskier asset.
The opposite of this is concentration, picking one bet and going all in on it. This is clearly a riskier proposition with a much bigger payout if you are right. Jeff Bezos went all-in on Amazon and got paid. But that could have easily gone the other way and we might not have ever heard of him.
Now we can debate conviction and how that leads to different levels of concentration but that is not the point here. The point is what happens if you want to be diversified? The answer in my mind is to own treasuries….and guess what? The zig when the other zags part is playing out right now. Treasuries are falling as the majority of the stock market is trading at all-time highs.
The problem that I see is that since about 2008 / 2009 when the Fed embarked on an easy money policy, we have become spoiled. Stocks and treasuries have trended up together. Investors with a diversified portfolio appeared to be getting paid on both bets. (Spoiler Alert: Appeared is the key word here)
But notice that from 2003 - 2007, stocks went up (bottom panel) while treasuries went down (top panel). Then with the global financial crisis raging, stocks went down and treasuries went up…zig zig!
As I was thinking about this, I wanted to see how much things have change. I looked at the rolling 20-day correlation of treasuries to the S&P 500. What I found was that while there are more instances of positive correlation since 2007, for the majority of the time, the correlation was negative…meaning that the two assets moved in different directions…zig zag!
So from a here, I will go with the basic assumption that a portfolio that mixes treasuries with equities accomplishes the goal of diversification depending on how they are weighted.
By the way, the Fed meeting was yesterday. Chairman Powell said that they are going to remain accommodative until 2024. Stocks went up and treasuries went down…zig zag!
I am taking the day off tomorrow. Have a great weekend!
*Nothing in these pages should be considered investment advice.