Multi-asset investors may have to rethink assumptions about stock-bond correlations if inflation and interest rates remain high for a sustained period, a recent longitudinal study has found.
Based on a comprehensive analysis of US and UK share and bond returns dating back to at least 1875 and more recent data for other jurisdictions, the report found a clear link between the asset class correlations and inflation/rate regimes – at least over the last 70 years or so.
Laurens Swinkels, a co-author of the study and head of quant strategy for the Sustainable Multi Asset Solutions of Dutch manager Robeco, said in an interview this month that the findings suggest modern monetary policy lies behind the historical divide in the data series.
“Before 1952, we found limited explanatory power but post-1952, inflation and real interest rates emerged as significantly determining the correlation between the two asset classes,” Swinkels said. “This is likely driven by more counter-cyclical central bank monetary policies. High real interest rates or inflation levels tend to coincide with positive stock-bond correlation, which is not favorable for multi-asset investors looking to reduce risk by investing in both asset classes.”
He said the study coincided with a real-time swing to positive stock-bond correlations during the sharp inflationary upswing over 2020-2023 where both assets slumped in unison for “prolonged periods”.
“While our research was initially historical, our research took on a practical dimension through experiencing these inflationary periods, which really underlines the relevance of these discoveries,” Swinkels said.
The researchers found shares and bonds tend to be positively correlated when inflation lingers at 3 per cent or more and rates rise in unison.
“… investors might need to adjust their equity holdings downwards during periods of positive correlations to maintain a consistent risk level,” he said.
Importantly, the results hold mostly for ‘safe haven’ countries such as the US with stock-bond correlations “more consistently positive” elsewhere.
“This international dimension to our research challenges the assumption that findings based on US markets are universally applicable,” Swinkels said.
Overall, the study says investors should take account of the outsize influence of the inflation and interest rate regime when making asset allocation decisions.
“… secular changes in inflation and the real rate level can materially impact multi-asset portfolio risk,” the paper says. “This implies that good risk management practices should include the analysis of different macroeconomic scenarios resulting in variations of the stock-bond correlation level.”
Swinkels authored the study along with Robeco colleague, Roderick Molenaar and State of Wisconsin Investment Board senior investment staff, Zhenping Wang and Edouard Sénéchal.