This is a long-term look at the interaction between stocks (the S&P 500) and bonds (10-Yr Treasuries), in pictures.

From 1962 to the present, there is little correlation between the return of 10-Yr Treasuries and the appreciation of the S&P 500. “Return” includes price change and coupon, “appreciation” does not include dividends. Roughly speaking, the prices of stocks and bonds tend to go up together, but not often enough to bank on it. This phenomenon is why they are complementary asset classes in a diversified strategy. This is also why you should never count on a short-term phenomenon (like TLT leading the SPY) continuing for more than a couple of days or weeks at a time. This is also why you should put the über-bears on “ignore” when they harp on rising yields killing stocks.

There is a good correlation between yield and subsequent 1-year return on Treasuries. Duh. But it’s not a GREAT correlation; just because prices are cheap on bonds don’t mean they can’t get cheaper.

It’s obviously not as simple as just finding a range of Treasury yields where it’s better to buy bonds than stocks. Or is it?

If you buy a fresh, new 10-Year Treasury and hold it to maturity, the yield is a proxy for the 10-year annualized return. Of course, re-investing the coupon boosts the yield to maturity, but that’s another matter. Historically, and generally speaking, the higher the interest rates have been at any point in time, the better the long-term appreciation prospects of stocks are. Duh! Very high interest rates seem to imply that, generally speaking, (1) stocks have already been damaged somewhat by the very high rates and (2) rates will soon be lowered and liquidity injected to boost the stock market, er, “economy.” When rates get super-high, however, it seems like the 10-year potential of the stock market to absorb the liquidity boost is maximized at 10-15% annualized. Therefore, if yields ever climb to the teens again, it may be best to buy and hold to maturity, possibly reinvesting the coupon in stocks.

This is a little different than the first graph of returns, because all I’m capturing here is the change in yield, with no impact of the coupon, and the chart will look reversed because an increased yield is a decreased price. What’s important is that this chart only weakly confirms the conventional wisdom of falling yields and rising stocks. Yes, the vast majority of the time when yields fall over the course of a year, especially when they fall dramatically, the stock market appreciates, and yes, the most dramatic, balls-to-the-wall increases in stocks corresponded with periods of falling yields. But what gets missed, is that there are lots of times when yields and stocks went up simultaneously over the course of a year, sometimes dramatically. Here it is in a table format.

Keep in mind that the data set consists of monthly looks at bond yields and stock appreciation, starting in 1962. In that time period, for a year’s holding time, stocks managed to appreciate 73.7% of the time, which makes those idjits predicting a stock market decline every year look like, well, idjits. But I digress. What is interesting is that the most common combination, at 158 occurrences, is that stocks go up while yields go up! Yes, it is more likely for stocks to fall while yields are rising than while yields are falling, but by and large, stocks go up in the face of rising yields more often than not.