In the sea of red

In the sea of red of the decline stock and bond prices, there are two pieces of green. The VIX and the US 10-year bond yield. LOL!

The VIX is the famous Volatility Index. Whenever the market is in the selling mood, the index climbs.

The stock price and the bond price relations are very interesting pair. The famous basic diversification is 40/60 split. 40% in stock and 60% in bond. Natually, it means stock and bond prices move in different direction. However, that is not what happened recently. Both stock and bond prices dropped. Due to inflation, most central banks around the world increased interest rates hoping to reduce demand. Bond prices and interest rates move in opposite direction. Here is why. The constant is the absolute dollar amount paid regularly as interest to the bond holder. The interest rate of the bond equals this interest amount divided by the bond market price. Both interest rate and bond market price fluctuate in opposite direction. That is the mathematical explanation. Let’s talk about it from a bond market or investor point of view. Before the pandemic, the interest rates were lower than now. The bond issued at that time naturally pay lower interest amount because they don’t have to. The competitive bonds offer lower interest too. For example, say $15 per month. Now, the new bonds issued will have to pay higher interest. The investors who hold the old bonds would naturally want to sell the old bonds and buy the new bonds. Therefore, the old bonds prices decline.

The key question is what the investors should do at such market condition with both stock and bond prices are down. Or the right question is that the investors should have done to prepare for such situation. One common advice is to buy gold. However, it doesn’t work this time because the US dollar was so historically high due to US central bank – the Fed aggressive interest hike to combat inflation. The investors around the world want the US bonds to take advantage of the high interest so they want US dollars. This high demand of US dollars drove up the USD$ exchange rate. The gold price and US dollar tend to move in opposite direction.  Click the link to see more detailed explanation.

The popular theory is that gold can preserve the value to fight inflation. It doesn’t work this time. It was also said that real estate can help fight inflation. If someone just bought a property during the pandemic, the price of property might be lower now. Just can’t win. Ok, what then? Some might say we need cash in our portfolio for time like this. Since we can’t predict the future, we need some cash all the time just in case. Perhaps the key is rebalance the portfolio regularly. When we design the portfolio mix, each asset/security has a mix according to our investment horizon, risk tolerance, investment goals, etc.  It can be a percentage or absolute dollar amount.  For example, the 40/60 stock and bond split as simple illustration.  We try to maintain the 40/60 to maintain the mix by do some necessary trading.  Then, we will sell certain asset when its price is high and buy certain asset when its price is low.

For those with more than 5 years investment horizon, it is a good opportunity to buy since almost everything is down now. Of course, we don’t know when it is bottom. I don’t aim for that. Honestly, I don’t have the crystal ball. With 20% to 35% down from the peak, I know certainly that I am already getting a bargain.

Happy shopping!