September hurt shareholders, not only because stocks fell but also because the things they’d bought to protect their portfolios also fell. From the S&P 500’s high on the 2nd of the month, stocks, Treasurys, gold, bitcoin and the VIX volatility index all dropped.
This total failure of hedging is unusual, but investors need to get used to the idea that Treasurys no longer provide the ballast for a portfolio.
It wasn’t just the normal pattern of asset returns that broke down. Within the stock market the correction in Big Tech upended many of the reliable ways to minimize losses. High-quality stocks, companies with strong balance sheets and reliable profits, fell by more than the market. Smaller companies beat bigger companies.
Within the S&P 500, cheap or “value” stocks outperformed, although they still lost money. But while Big Tech-dominated growth stocks lost out among large companies, among small companies growth beat value. Sector performance followed no discernible pattern either. And stocks that normally rise and fall faster or slower than the market, known in market jargon as high or low beta, didn’t behave predictably.
Now the froth has been blown off the big disruptive growth stocks, we can hope that the normal market relationships will reassert themselves. But the biggest hedge against losses, Treasurys, probably won’t be back as a useful tool for years, if ever.
The problem showed up in Japan in the 1990s after the country slashed interest rates and government bond yields plunged. But it has become most obvious with Germany. In the eurozone crisis of May 2011 to July 2012, German 10-year bunds gained 25%, similar to the loss on eurozone stocks. But by this year the plummeting yield and already-negative interest rates meant there was little more to gain: Bunds made almost nothing from the February stock-market high to the low, and have provided essentially nothing since (Japanese bonds have lost investors a small amount).
Treasurys have now followed suit. In the first phase of the pandemic they made roughly 10%, before the brief period of chaos in the bond market. But since then they’ve been basically flat, giving investors little to no protection—including inflicting a small loss as stocks fell from the Sept. 2 high.
The problem is that, with yields so low, it is hard for them to fall much further, causing prices to rise. The Federal Reserve might still step in with a new Operation Twist to buy more longer-dated Treasurys, which could lower the 10-year yield a bit from its current 0.7%. But even if it was reduced to zero, that would offer a paltry potential price gain of just 7% from the bonds.
Of course, the Fed could follow Japan and Europe in taking interest rates negative, which would create more space for bond…