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A Look at Stock-Bond Correlation in Different Inflation Regimes

Daniel DeWoskin, Senior Quantitative Researcher 

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 (Fan and Mitchell (2017), Equity-Bond Correlation_Graham Research_2017.pdf (grahamcapital.com), DeWoskin et al. (June 2020) The Winter’s Tail – Protecting Against Equity Selloffs June 2020.pdf (grahamcapital.com), DeWoskin et al. (July 2020) In Search of Negative Beta.pdf (grahamcapital.com)), 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. 

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