The interplay between liquidity and economic growth

Sarang Kulkarni
13 September 2019

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Bonds go down when equities go up, is the common perceived wisdom among investors.

However, this has not quite held true when it comes to the performance of global credit in recent years.

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Looking at total returns from the S&P 500 and the Bloomberg Barclays Global Aggregate Credit indices over the past five years, a negative correlation between equities and bonds seems to have been the exception rather than the norm. What has been going on?

Financial market returns are driven by liquidity and economic growth. It is the interplay between both of these that sets the tone for performance.

Low interest rates and quantitative easing in the years following the Global Financial Crisis supported the performance of both credit and equity markets through increasing liquidity.

When the US Federal Reserve recommenced its programme of hiking rates in 2015, reduced liquidity in the market weighed on returns for both equities and global credit.

The course was reversed again when the Fed recently cut rates.

The market's outlook on growth too has changed. Signs of a synchronised global recovery have given way to a sprouting of recession risks, with the rise of populist politics a significant challenge to growth - whether within the UK with Brexit, Europe with Italy or the US-China tariff clash.

Fixed income credit can play a vital role within a broad investment portfolio, providing diversification, solid risk-adjusted returns, income and liquidity.

We believe investors should benefit from a defensive strategy in their portfolios.

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Investment grade credit is a good option, as it should perform well in the current environment, and remain relatively defensive in a more material slowdown.

Sarang Kulkarni is a portfolio manager at Vanguard