Graham Quant Log

A Look at Stock-Bond Correlation
in Different Inflation Regimes

Daniel DeWoskin, Senior Quantitative Researcher
March 2, 2023

In recent years, investors have relied on the persistent negative correlation of bonds to equities to build mixed stock-bond portfolios that hedge out some of the risk of an equity market downturn. In previous white papers, such as Equity-Bond Correlation: A Historical Perspective (Fan and Mitchell, September 2017), The Winter's Tail - Protecting Against Equity Selloffs (DeWoskin et al., June 2020) , and In Search of Negative Beta (DeWoskin et al., July 2020), we have explored this relationship and found that the negative stock-bond correlation has historically not always been so reliable. Here we show that the stock-bond correlation has actually varied over time with the transition between different inflation regimes. The figure below shows the 2-year rolling correlation between US equity and bond markets (represented by S&P 500 E-mini futures and US 10 Year futures, respectively) plotted against the annualized trailing 10-year average of US inflation (US CPI). A clear trend emerges: the negative correlation is historically only seen in periods of low inflation. Consistent with historical trends, as inflation rose beginning in mid-2020, the stock-bond correlation also rose, eventually turning positive.

                 Data Source: Bloomberg


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