If only investing were that easy or simple. The fact is, there are many factors at work, and this results in changing correlations between asset classes over time. Today, we are going to talk stock and bond correlations. For the obvious reason, there are many upset investors (and portfolio managers) that don’t like the fact that stocks and bonds have been moving in the same direction as one another (positively correlated). Everyone expects a degree of volatility in equities, but it sure helps the portfolio during periods when equities are going down if your bonds go up. That has not been the trend of late.

he contents of this publication were researched, written and produced by Purpose Investments Inc. and are used herein under a nonexclusive license by Echelon Wealth Partners Inc. (“Echelon”) for information purposes only. The statements and statistics contained herein are based on material believed to be reliable but there is no guarantee they are accurate or complete. Particular investments or trading strategies should be evaluated relative to each individual's objectives in consultation with their Echelon representative.

It is pretty easy to see in the above scatter plots of monthly stock/equity returns vs bond returns [the purple line is the trend]. From 2009 until the onset of the pandemic in March 2020, monthly returns between stocks and bonds were really all over the place and didn’t show much of an underlying relationship. This would be ‘uncorrelated,’ which helps a portfolio’s diversification as the two assets behave rather independently. Now the chart on the right from the onset of the pandemic until now shows a different pattern. Only two months had stocks down and bonds up. And there are many months that both stocks and bonds were lower or higher together. Again, this provides less diversification benefit if they are moving in the same direction. 

So, have market dynamics changed to neutralize the benefits of combining stocks and bonds in a portfolio? Not so fast. First off, there are so many strange dynamics afoot in the markets today. Given the lingering reverberations caused by the pandemic, jumping to conclusions is not a good idea. Especially throwing out decades of data because of a year or so. The fact is, correlations do change over time, and they are currently more positive. 

So, if correlations are going to remain high, does this negate the benefit of stock and bond diversification? No. It may soften the benefit, but correlation measures direction, not magnitude. That is where beta comes in, measuring the degree of the move in stocks and bonds (thin black line in the above chart). Over the past two years, the correlation between bonds and stocks has risen to roughly 0.5, but the beta remains low at about 0.2. Meaning if your stocks fall 5%, bonds should fall by 1%. Since down 1% is better than down 5%, there is still a benefit.

Plus, the high correlation won’t stay high, either. One factor that does appear to have a strong relationship with the stock-to-bond correlation is the variability in central bank rates. When central bank rates are moving, the stock-to-bond correlation tends to be much higher. When central bank rates are stable, the stock-to-bond correlation tends to be much lower. This certainly makes sense. Changes to the central bank overnight rate changes the risk-free rate, either up or down. The risk-free rate is a component in the valuation of both stocks in bonds, so changes impact both asset classes in the same direction. 

Portfolio Construction

Given the outlook for central bank rates certainly points to continued action in the current fight against inflation, the bad news is this will contribute to keeping the stock-to-bond correlation higher. That being said, a higher correlation isn’t always bad. When inflation starts to roll over, the market will likely start to price in a cooling of the overnight bank rate, which may very well lift the prices of both stocks and bonds simultaneously. Yay, positive correlation.



The yin and yang of stocks and bonds aren’t broken. Maybe people just thought it was a hard rule or constant instead of a variable relationship over time. The diversification benefits between stocks and bonds may not be as strong as in years past, but they will be again. Certainly, explore ‘new’ diversification strategies, but please don’t mess with the core of portfolio construction because of a couple of years of data. Besides, buying bonds that yield 5% does feel a lot safer than buying them a few years ago, yielding 2%. Not saying we love bonds, but we sure don’t dislike them anymore.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.
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