Investors always look for the best places to put their money given the risk they are willing to take. The appetite for risk is improving.
On Thursday this week the stock market opened broadly higher and the bond market sold off. Investors largely moved their capital out of the generally lower risk bond markets into risk-taking stock ventures.
A catalyst for the stock market jump was a better than expected report on the job market. The U.S. Labor Department reported that although initial claims for jobless benefits climbed 25,000, continuing claims drawn by workers for more than a week fell 54,000 in the most recent period. Further, the four-week moving average of initial claims declined 8,250 from the previous week.
This weekly report on the job market is often looked to as an indicator of changes likely to be seen in the overall unemployment rates. Employment declined dramatically last June and the unemployment rate remains high at 9.5 percent. A drop in claims for unemployment insurance may indicate that the next employment report in early August will be brighter.
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On this and other good news about corporate earnings stocks rose nearly 2 percent early Thursday. Meanwhile, U.S. Treasury and corporate bond prices were lower.
Stock and bond prices don’t always move inversely. In financial crisis like that of the past year all capital assets may fall in balance.
However, in the longer run stocks and bond returns do move together, that is, they are uncorrelated. Large company stocks like those in the Dow 30 index return a continuously compounded return of 9.7 percent from 1925 through 2005. Over the same period long-term Treasury bonds returned 5.25 percent.
The correlation between these two assets classes over this period is only 0.12. This means investors have can lower their risk by holding a combination of both. Diversification has its benefits.
A portfolio with 50 percent stocks and 50 percent long-term Treasuries returned 7.5 percent from 1925 through 2005 with far less volatility than stocks alone. While stocks were down on average 35 percent in 2008 a 50/50 portfolio was off on 17 percent.
This week it looks as if investors are hungry for the higher expected returns in stocks. We should remember what our mothers always told us: “Eat a well-balanced meal.”
Since 2000, Peter R. Crabb has been a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.