Long Term Historical Correlation of S&P 500 with Interest Rates

In the previous post I highlighted how the correlation of rates and the S&P 500 has turned slightly negative, which is an infrequent occurrence judged over the last 10 years.  The risk on/risk off trade has thrived on the idea that rates and stocks are positively correlated (i.e. when stocks go down bonds rally (rates fall) and when stocks go up bonds sell off).  This is likely a function of the fact that the risk premium (as opposed to inflation expectations) is the primary driver of price fluctuation in the current environment.

For most of the 20th century, risk premium was less important than inflation premium though, which led to an inverse correlation of rates and equities.  Because inflation was a greater component of a company's cost of equity, as inflation expectations fell, interest rates fell (as did the cost of equity) and stocks rallied along with bonds.  If inflation ever becomes a dominant theme again, then one might expect the correlation that has been the heart of the risk on/risk off trade to get turned on its head.  What happens to the algo guys if that happens?

Correlation of Rates and S&P 500

Operation twist has had the opposite effect on rates that outright QE has had, but equities have rallied during twist just like they did during QE1/2.  This has lead to a divergence between equities and interest rates over the past year.  Previously equities and rates had been relatively correlated: when equities moved higher so did interest rates.  Recently though, the daily correlation has broken down and over the past year has actually turned slightly negative.

Facebook Mostly Uncorrelated to S&P 500

The S&P 500 is down slightly with a couple hours left in the trading session.  However, one stock that is bucking the trend is Facebook, which is up almost 6% on news that Mark Zuckerberg wont be selling any of his shares for at least a year.

While the divergence is mostly just a quirk of the news-flow, it seems that this isn't the first time in Facebook's short history as a publicly traded stock that the daily change of FB is in the opposite direction of the general market.  In fact, because FB has mostly gone straight down since its debut, the stock has shown almost no correlation with the S&P 500.  Since it began trading, the correlation coefficient is 0.02 and since the start of the 3rd quarter, it is -0.15.  In the context of modern portfolio theory, FB is a great hedge!