The surface examines the relationship between bonds and equities over time. In particular, the pre- and post- crash behavior contains useful information as it diverges from what might be considered the normal regime.
The plot depicts normalized intraday price returns between US 10-year note futures and E-mini S&P 500 futures for 2 months at a time. A representative sample of the returns is used, and these are normalized by taking their rank over each period.
As volatility increases, we can see that the surface warps as returns are drawn to their relative extremes in the corners of the surface. Volatility dynamics along with changes in the bond-equity relationship interact to form rich surface characteristics.
A consequence of using intraday returns is that in high volatility periods returns will typically not be near the median, depicted by the center of the surface. Instead clusters tend to appear in the surface along the diagonals, either showing positive association where stocks are moving in the same direction as bonds, or the reverse.
From 1997 through 1998, the relationship is initially a weak one, with returns occupying each of the four quadrants. Late 1998 sees returns drawn to each of their respective extremes until early 1999, forming a diagonal. This period corresponds to a spike in equity volatility.
In late 1999 another diagonal appears, this time in the opposite direction, representing the less common positive association between bond and stock returns. 2000 then sees a less sharp diagonal and consolidation towards the median. The diagonal becomes stronger in mid-2001, persisting but in a weaker state until 2002 when it periodically strengthens. From 2004 through mid-2007, a consolidation towards the median occurs in both asset classes, but with weak positive association sporadically appearing.
Beginning in September 2007, a strong negative relationship appears as equities begin their downward spiral and bond yields decline. Wide swings occur in equities along with bonds, reducing the concentration along the diagonal as the market crashes in the following year.
The diagonal reappears in 2012, almost immediately following the high volatility period in August 2011 that continued for the remainder of that year. Finally, once we reach the post-crash period in 2012, the surface consolidates towards the center as tail events diminish further. This reduction in volatility continues to persist until the beginning of the recent China stock market crash.
The relationship between stock and bond price returns is related to investor risk aversion. In crisis periods, as stocks decline investors are drawn to assets perceived as safer. This results in bond prices increasing, and yields decreasing. For this reason the high volatility periods correspond to a negatively associated diagonal line in the surface. Recognition of prevailing market conditions is of paramount importance when engaging in investment, both in terms of risk management and timing.