The chart below compares the absolute return of an investment in the S&P 500 vs. the excess return of an investment in the investment grade financial bond index (as compared to Treasuries) over rolling three-month periods going back 10 years. Note that pre-financial crisis there was a small relationship (even less so the prior decade) with the return streams below showing an r-square from 1988-June 2007 of less than 0.20. Since that time, an investment in the S&P 500 and financial bonds have been remarkably similar in terms of performance with an r-square of 0.56.
Source: Barclays Capital / S&P
Maybe financials are becoming a bigger part of S&P500?
ReplyDeleteAs of this spring, financials were at their 20 year average (around 15% of the S&P 500). See here: http://tinyurl.com/3clg9bf
ReplyDeleteFollowing the recent sell-off, they are probably down another few percentage points.
That said... remember, this is financial bonds (not equities).
As the amount of financial leverage in the economy and financial system get higher, financial bonds become more equity-like in performance, as they depend more heavily on strong profitability of those that they finance in order to expect payback in full.
ReplyDeleteAlso, the assets they finance have inflated values because of the growth in borrowing power, which reduces the odds of being paid back in full.
As the private sector delevers, this correlation should fall. If we get back to a low leverage environment like 1941-1984, it should disappear.
Thanks for stopping by David
ReplyDeleteVery interesting post, thanks.
ReplyDelete