(PUB) Investing 2016

I don’t believe there is much news that isn’t already built into the prices of most high-yield bonds at this point. Oil has already come close to touch- ing $25 per barrel. Frackers and their ilk have already shut down wells and begun the process of trying to work out their debt loads. Unless there is another huge downtick in the price of oil, which I can’t really see happening, most of the bad news is, as I said, already built into junk bond prices. This bad news is reflected in the yield you are being paid—High- Yield Corporate’s 6.56% SEC yield is 5.42%, or 542 basis points, more than Intermediate-Term Treasury ’s 1.14% yield. The black line in the graph to the right shows this difference in yield (or spread) over the past 22 years. As IT’S THE TALK of the financial cable news shows and various publications and blogs, but the current accepted wisdom is simply wrong. Stock prices and oil prices are not highly correlated, and to make a big deal over a few weeks of trading is non- sense. While we’ve seen a bit higher correlation between the two recently, over virtually any period of time longer than it takes for a stock trader to spew such silliness, stock markets and oil prices have shown an average correla- tion of around 7% to 10%. That’s a far cry from 100%. Take a look:

certainly possible that spreads could widen further (it happened in the credit crisis), but when spreads have reached this level in the past, you’ve wanted to be buying high-yield bonds, not sell- ing. The blue line on the chart shows the difference in performance between High-Yield Corporate and Intermediate- Term Treasury over the ensuing year. On average, High-Yield Corporate out- performed Intermediate-Term Treasury by 9.2% in the 12 months after spreads were over 500 bps. There may be some more short-term pain to come, but if you’d bought High- Yield Corporate at these levels in the past, you probably felt pretty darned smart about it if you held on. I’m stick- ing with High-Yield Corporate for the moment, and suggest you do, too. n But let’s take the calculation out just a little bit further to determine the strength of this supposition that stock and oil prices move together. I looked at rolling five-day periods just since the end of 2015, and the average correla- tion drops to 45%! But take the data out a bit further, say more than 25 years, and the average correlation over five- day periods drops to an 8% average! The same thing happens when you look at longer periods of, say, correla- tion over 100 days or 250 days or even 20 days. Correlation, on average, drops to a meaningless level—about 7%. >

When High Yield’s Spread Is High, Excess Returns Follow

-40% -30% -20% -10% 0% 10% 20% 30% 40% 50%

1200

Spread over Int-T. Treas. Excess 12-mo. return

1000

800

600

400

200

0

1/94

1/96

1/98

1/00

1/02

1/04

1/06

1/08

1/10

1/12

1/14

1/16

you can see, spreads have only been this wide on three other occasions in the past two decades: 2002, 2008–09, and 2011 (when I first purchased the fund in the Model Portfolios ). It is

CORRELATION Oil and Stocks in Sync—Not!

First, here’s what’s happened over the past few months, on a daily basis. The left-most graph below shows each day as either 100 (both stocks and oil move in the same direction for the day) or -100 (stocks and oil move in differ- ent directions). Since the end of June 2015, stock prices and oil prices have moved in the same direction on 112 days, or 65% of the time. That’s a pretty high correlation, but nowhere near 100%. The number rises a bit in the first two months of 2016, when over 40 trading days, stocks and oil moved in the same direction 75% of the time.

Daily Oil-Stock Co-Movement (S&P 500, Brent)

Rolling 100-Day Correlation (S&P 500, Brent)

Rolling 250-Day Correlation (S&P 500, Brent)

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100%

100

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100%

100-day Avg.

250-day Avg.

0

-100

6/15

7/15

8/15

9/15

1/16

2/16

2/89

2/92

2/95

2/98

2/01

2/04

2/07

2/10

2/13

2/16

2/90

2/92

2/94

2/96

2/98

2/00

2/02

2/04

2/06

2/08

2/10

2/12

2/14

2/16

10/15

11/15

12/15

The Independent Adviser for Vanguard Investors • March 2016 • 5

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