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Let's say "Tom" allocated a large amount of capital in some fund's (it's TIAA-CREF, actually) bond assets.

In our fictional scenario 2 things are going to happen in the next year:

  1. The equity markets will crash due to a Black Swan event.

  2. Interest rates will keep rising.

The question is: what will happen to the valuation of Tom's bond holdings after the equity crash?

Here's what Tom thinks is the most likely scenario:

a) Bond Price Bump due to Demand: Initially, as market money moves out of equities into bonds, the bond prices will rise (for a short while). So Tom will see a short-term gain.

b) Bond Price Decline due to Rising Interest Rates: Eventually, the bond prices will start falling again (due to rising interest rates) and cause a serious decline in Tom's holdings.

What do you think? Is Tom in the correct ballpark?

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    I imagine it depends on what kind of crash in the equities markets. A truly horrific crash could cause everything to fall, particularly if it was large enough for something like Vanguard or Fidelity to go under. – Joe Oct 9 '17 at 2:36
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what will happen to the valuation of Tom's bond holdings after the equity crash?

This is primarily opinion based. What will happen is generally hard to predict.

Bond Price Bump due to Demand:

Is a possible outcome; this depends on the assumption that the bonds in the said country are still deemed safe. Recent Greece example, this may not be true. So if the investors don't believe that Bonds are safe, the money may move into Real Estate, into Bullion [Gold etc], or to other markets. In such a scenario; the price may not bump up.

Bond Price Decline due to Rising Interest Rates:

On a rising interest rates, the long-term bonds may loose in value while the short term bonds may hold their value. Related question How would bonds fare if interest rates rose?

  • Thank you for the "the long-term bonds may loose in value while the short term bonds may hold their value"... I suspected that was the case, and one more data point makes it stronger in my mind. – thanks_in_advance Oct 9 '17 at 17:25
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I agree that the cause of the crash can make a huge difference in the effect on the bond market. Here's a few other possibilities:

  • The crash is due to some underlying business market problem (like the dot-com bust), which also increases the risk of default, causing bond prices to fall.
  • The crash is due to to some underlying economic problem that affects the bond markets negatively as well.

All that to say that there's no definitive answer as to how the bond market will respond to an equity crash. Bonds are much more highly correlated to equities lately, but that could be due to much lower interest rates pushing more of the risk of bonds to the credit worthiness of the issuer, increasing correlation.

  • Would appreciate a detailed clarification of the mechanism involved in "increasing correlation" in "but that could be due to much lower interest rates pushing more of the risk of bonds to the credit worthiness of the issuer, increasing correlation." – thanks_in_advance Oct 9 '17 at 17:23
  • Bonds have two main factors in their price - interest rates and default risk. If interest rates are low, more of the risk shifts to default risk. – D Stanley Oct 9 '17 at 18:35

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