The S&P 500 is going down as I type. In fact, most global equity markets seem to have peaked since the beginning of this year. This is the time when holding on to some safe-haven assets in your portfolio might help to stabilize your portfolio against the volatility in the equity markets. However, many assets are deemed to be safe havens but they all have their own unique characteristics that make some better safe havens than others under different circumstances. Some assets have been touted as safe havens but they do not really hold up in practice. So let's take a closer look at some of the common safe-haven assets out there, and why they might behave as safe-havens. We will then look at the past correlation of these assets with the S&P 500 to see if they had been reliable safe havens in the past.
Why Is Correlation A Key Criteria For Safe Haven Assets?
If you are not sure what is correlation, you can click on this link to see a short video explanation. But in short, safe-haven assets should exhibit a negative correlation with the S&P 500 during an equity market crisis because we need the safe-haven assets to go up as the S&P 500 goes down. In this way, the profits from the safe-haven assets can offset some of the losses from equities. Therefore, it is key to have a negative correlation during an equity market sell-off. It is less important to have a negative correlation when equity markets are going up. With that in mind, let's look at some common safe-haven assets out there.
Gold
When people think of a safe haven, they will most likely think of gold. As a physical commodity, the price of gold is not often influenced by the decisions of central banks on interest rates, and unlike paper currencies, its supply cannot be manipulated by actions such as printing. Even though the gold standard has been abolished since 1933, market participants still view gold as a hard tangible asset to store wealth. Even governments around the world still hold a significant amount of gold as part of their reserves. Below is the historical rolling 60-day correlation of SPDR Gold Shares ETF (GLD) with the SPDR S&P 500 ETF (SPY).
Gold does not seem to have any relationship with the S&P 500 as evidenced by the long-term average correlation of close to zero. However, what is interesting is that during periods of equity market downturns (pink-shaded regions), gold is negatively correlated to the S&P 500 most of the time. Hence, gold seems to fulfill the important criteria of a safe haven.
Government Bonds
Government bonds are essentially fixed-term debt issued by a government, which have periodic interest payments. There are different maturities of debt that can be issued. The only difference between them is the amount of time before you will be reimbursed in full. Treasury bills have maturities of a year or less, while treasury bonds can have maturities of ten years or more.
Investors tend to have more confidence in bonds issued by governments of developed economies – the most popular are US treasury bills. Their status as a safe haven is based on the credit status of the US government, and the high quality of income in US dollars. With such a stable income behind the asset, investors consider government bonds to be a risk-free safe haven, especially because anything invested will be repaid in full once the bill has matured.
The US 10-year treasury note is considered one of the safest assets by market participants. Below is the historical rolling 60-day correlation of the iShares 7-10 Year Treasury Bond ETF (IEF) with the SPDR S&P 500 ETF (SPY).
US government bonds tend to have an inverse relationship with the S&P 500 as evidenced by the long-term average correlation of -0.35. And just like GLD, IEF also tends to exhibit a negative correlation with SPY during periods of sharp equity market sell-off.
US Dollar
For over 50 years, the US dollar has been one of the most popular safe havens during economic downturns. It exhibits some safe-haven characteristics. Most crucially, it is the most liquid currency on the forex market.
This confidence in the US dollar came from the 1944 Bretton Woods agreement, which introduced the fixed currency system and made the dollar the world’s primary reserve currency. Even after this system was abolished in 1971, the US dollar retained its position as a safe haven because it represented the world’s largest economy.
The value of a currency is always in relation to another currency. I am based in Singapore so let me use my local currency as a reference for the value of USD. Below is the historical rolling 60-day correlation of the USD/SGD currency pair with the SPDR S&P 500 ETF (SPY).
USD/SGD has a slight negative correlation with the S&P 500 over the long term. It does not exhibit as clear a negative correlation with SPY as compared to IEF during stock market sell-offs. However, there were periods in the past where the negative correlation is strong, for example in 2008 and 2010.
Japanese Yen
The Japanese yen is thought of as a safe haven as it often appreciates against the US dollar when US stocks and government bonds experience volatility.
Post-World War II, the Japanese economy was restructured, which enabled it to catch up with other global economies. The Bank of Japan (BoJ) became highly respected and the yen was established as a major global currency. Despite continued interventions from the government, the liquidity of the yen has continued to attract investors in times of financial distress.
The yen earned its reputation as a safe haven due to Japan’s high trade surplus versus its debt. The value of foreign assets held by Japanese investors is far higher than Japanese assets owned by foreign investors. This means that during a global equity market sell-off, money moves out of other currencies and back into domestic markets, which strengthens the yen.
Again, let me use SGD as the reference for JPY strength. Below is the historical rolling 60-day correlation of the JPY/SGD currency pair with the SPDR S&P 500 ETF (SPY).
Similar to the US dollar, the Japanese yen also has a slight negative correlation with the S&P 500 over the long term. It also can exhibit a strong negative correlation with SPY during a stock market sell-off.
Swiss Franc
Common reasons that investors favor the Swiss franc as a safe-haven currency include the political neutrality of the Swiss government, the strong Swiss economy, and its developed banking sector. The country’s independence from the EU has also made it a popular haven for capital during negative political and economic circumstances. Below is the historical rolling 60-day correlation of the CHF/SGD currency pair with the SPDR S&P 500 ETF (SPY).
In line with the earlier two currencies, the Swiss franc also has a slight negative long-term correlation with the S&P 500. It also exhibits a negative correlation during "risk-off" periods.
Defensive Stocks
Defensive stocks describe the shares of companies that are involved in providing goods and services such as utilities, consumer staples, and healthcare. They are considered safe-haven assets because they are likely to remain stable due to the constant demand for their products, even in periods of economic instability. Below are the historical rolling 60-day correlations of the respective defensive sector ETFs with the SPDR S&P 500 ETF (SPY).
All the defensive sector ETFs have positive long-term correlations with the S&P 500. Only the utilities sector ETF exhibited a negative correlation during some of the past stock market sell-offs. Hence, it looks like only XLU can be regarded as a possible safe-haven candidate whereas XLP and XLV most likely can only be expected to lose less than the S&P 500 during a stock market sell-off.
Actual Past Performance
Having looked at the characteristics of the various common safe-haven assets and their past correlation with the S&P 500, let's see how they actually performed during significant past crisis events. I've included the current crisis that we are experiencing even though we might still be in the midst of it.
US government bonds, gold, and the safe-haven currencies all delivered gains during most of the past crises. Of the defensive sectors, only the utilities sector managed to deliver gains in some of the past crises although it can also lose a lot during significant crises like the Great Financial Crisis and COVID 19.
The above performance of the various assets is in line with the correlation analysis that we have done earlier. US government bonds and gold can be relied upon as safe-haven assets given their long-term negative correlation with the S&P 500 in addition to the fact that they tend to exhibit a strong negative correlation during a stock market sell-off. The same can be said for the safe-haven currencies as well. As for the defensive stock sectors, we shouldn't expect them to do wonders during a severe stock market crisis because they are still exposed to equity market risk. The best that they can do is to lose less than the broad market during "risk-off" events.
What About Cryptocurrencies?
One of the touted benefits of cryptocurrencies is that they can also act as a safe-haven asset. Some advocates have even gone so far as to say that it is a replacement for gold. So let's do the same analysis for the two main cryptocurrencies, Bitcoin and Ethereum, and see whether such views are valid. Below are the historical rolling 60-day correlations of the respective cryptocurrencies with the SPDR S&P 500 ETF (SPY).
Both Bitcoin and Ethereum have a slight positive long-term correlation with the S&P 500. Bitcoin only ever exhibited a negative correlation during a stock market sell-off in 2015 (The price data for Ethereum in Yahoo! Finance only started in 2017). In all the subsequent "risk-off" periods, both Bitcoin and Ethereum exhibited strong positive correlations with SPY. Hence, we can expect both to lose together with SPY during those periods.
Truth Revealed
Let's now see the actual performance of Bitcoin and Ethereum during past stock market sell-off events including the current one we are in.
As expected, Bitcoin only generated strong gains during the Shanghai Crash in 2015. In subsequent events, both Bitcoin and Ethereum lost money together with SPY, in some cases a lot more than SPY.
To be fair, cryptocurrencies are still fairly new and so things can still change but for now, cryptocurrencies cannot be considered a reliable safe-haven asset. At best, it can only be considered as a diversifier in an investment portfolio but even then, it should only be a very small allocation.
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