In
our
recently
published 2024
Diversification
Landscape report,
Christine
Benz,
Karen
Zaya,
and
I
took
a
deep
dive
into
how
different
asset
classes
performed
in
the
past
couple
of
years,
how
correlations¹
have
evolved,
and
what
those
changes
mean
for
investors
and
financial
advisors
trying
to
build
well-diversified
portfolios.
We
also
looked
at
correlation
trends
during
periods
of
rising
interest
rates,
elevated
inflation,
and
economic
recessions.
One
key
finding:
higher
inflation
usually
leads
to
closer
links
between
stocks
and
bonds,
reducing
the
benefit
of
including
both
in
a
portfolio.
The
resurgence
in
inflation
that
started
in
May
2021
made
market
conditions
much
more
challenging.
Supply
chain
disruptions,
a
tight
labour
market,
the
war
in
Ukraine,
and
strong
economic
growth
all
conspired
to
push
up
inflation
from
its
previously
benign
levels.
The
year-over-year
change
in
consumer
prices
rose
to
more
than
7%
by
the
end
of
2021
and
reached
as
high
as
9%
by
mid-2022.
Inflationary
pressures
eased
during
2023,
but
inflation
remained
above
the
Federal
Reserve’s
stated
target
of
2%.
Higher
inflation
marked
a
sharp
reversal
from
the
previous
regime.
For
most
of
the
previous
30
years,
conditions
were
unusually
benign
from
an
inflation
perspective.
Aside
from
a
brief
increase
in
the
mid-2000s,
inflation
had
generally
been
running
well
below
its
long-term
historical
average
of
about
3.2%.
Cooler-than-average
inflation,
in
turn,
created
close
to
ideal
conditions
for
stock/bond
correlations.
With
inflation
mostly
a
nonissue,
stocks
and
bonds
moved
largely
independently;
in
fact,
rolling
three-year
correlations
between
stocks
and
bonds
were
consistently
negative
(or
barely
above
zero)
from
November
2000
through
2020.
A
Sharp
Increase
in
Correlation
With
those
conditions
now
a
distant
memory,
it
shouldn’t
come
as
a
surprise
that
correlations
between
stocks
and
bonds
have
sharply
increased.
Correlations
between
stocks
and
bonds
edged
into
positive
territory
in
2021
and
jumped
up
to
0.58
for
the
full
year
in
both
2022
and
2023.
The
recent
uptrend
in
correlations
has
been
unusually
dramatic
but
not
unprecedented.
As
I
discussed
in
my previous
article,
the
stock/bond
correlation
has
often
been
positive
over
multiyear
periods.
For
example,
the
trailing
three-year
correlation
coefficients
between
the
two
asset
classes
were
consistently
above
zero
from
August
1966
through
August
1974.
Stock/bond
correlations
were
also
consistently
positive
from
October
1974
until
late
2000.
We
also
looked
at
correlations
over
specific
periods
of
higher
inflation,
generally
defined
as
periods
when
year-over-year
inflation
increased
by
at
least
5%
and
remained
high
for
at
least
six
months.*
As
shown
in
the
table
below,
correlations
between
stocks
and
bonds
rose
during
some
but
not
all
periods.
In
general,
correlations
increased
the
most
during
periods
when
inflation
was
both
high
(in
the
double
digits)
and
protracted
(lasting
at
least
three
years).
The
post-World
War
II
era
saw
an
unusually
high
spike
in
inflation
(driven
by
the
removal
of
wartime
wage
and
price
controls,
combined
with
large
numbers
of
troops
coming
home),
but
the
increase
in
consumer
prices
lasted
only
about
a
year.
More
recently,
surging
economic
growth
in
China
fuelled
rising
consumer
prices
in
2007
and
2008,
but
inflation
remained
below
6%
and
lasted
less
than
a
year.
The
most
dramatic
correlation
upturns
took
place
in
the
periods
from
February
1966
through
January
1970
(driven
by
low
unemployment
and
surging
economic
growth)
and
February
1977
through
March
1980
(driven
by
soaring
oil
prices,
the
oil
embargo
and
related
price
shocks,
and
expansionary
monetary
policies).
Correlations
ended
up
in
a
similar
range
(0.26
and
0.28,
respectively)
in
both
periods.
Thanks
to
the
rapidly
shifting
landscape
for
both
interest
rates
and
inflation,
the
recent
upturn
in
stock/bond
correlations
has
been
even
more
pronounced.
Portfolio
Implications
–
Should
You
Avoid
Bonds?
There
are
a
couple
of
key
lessons
to
draw
from
these
patterns.
For
one,
the
environment
for
both
inflation
and
interest
rates
has
fundamentally
changed.
As
long
as
the
outlook
for
inflation
and
interest
rates
remains
uncertain,
the
correlation
between
stocks
and
bonds
will
probably
remain
higher
than
in
the
past.
Indeed,
correlations
between
stocks
and
intermediate-term
government
bonds
stood
at
about
0.6
for
the
trailing
12-month
period
through
April
30,
2024.
That
doesn’t
necessarily
mean
investors
should
avoid
bonds,
however.
Stocks
and
bonds
tend
to
move
more
in
tandem
during
inflationary
periods,
but
bonds
can
still
provide
significant
diversification
benefits,
as
well
as
play
a
critical
role
in
providing
ballast
and
reducing
risk
at
the
portfolio
level.
¹
Correlation
means
that
asset
classes
tend
to
move
in
the
same
direction
*
Inflationary
periods
are
based
on
the
parameters
described
in
Neville,
H.,
Draaisma,
T.,
Funnell,
B.,
Harvey,
C.R.,
&
Van
Hemert,
O.
2021.
“The
Best
Strategies
for
Inflationary
Times.” ssrn.com/abstract=3813202.
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