The relationship between stock and bond returns is a fundamental determinant of risk in traditional portfolios. For the past two decades the stock/bond correlation has been consistently negative, and investors have largely been able to rely on their bond investments for protection when equities sell off. But this hasn’t always been the case, and macroeconomic changes – such as higher inflation uncertainty – could lead to a reappearance of the positive stock/bond correlation of the ‘70s, ‘80s and ‘90s. This would have broad implications for investors, either increasing portfolio risk or forcing allocation changes likely to reduce expected returns.
In this article we set out practical steps to prepare for such an outcome: first, understanding the drivers and implications of this ‘golden parameter’ before it loses its luster, and second, revisiting alternatives – which could play a crucial investment role in a positive stock/bond correlation world.
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We thank Alfie Brixton, Jordan Brooks, Pete Hecht, Antti Ilmanen, Thomas Maloney and Nick McQuinn for their work on this paper. We also thank Jim Cavanaugh for helpful comments.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.