The era of easy diversification may have ended

 

• Stock-bond correlations have shifted sharply higher in recent years, reaching levels not seen since the 1990s. The 3-year rolling correlation is near +0.6, suggesting that equities and bonds are moving more in tandem than in opposition.[1]
• The recent jump has been driven by the markets’ growing acceptance that Treasury yields could remain higher-for-longer, which has historically led to higher correlation between stocks and bonds.
• Elevated inflation expectations have driven the higher-for-longer narrative, as has a rising Treasury term premium—the additional yield investors demand to hold longer-dated Treasuries instead of rolling short-term T-bills—amid concerns over U.S. debt levels and geopolitical tensions.
• High correlation environments have proven challenging for the traditional 60/40 portfolio as bonds no longer serve as a ballast to volatile equities and underscore the importance of alternative sources of diversification, income and growth potential.

 

 

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