Where are we headed on the correlation between stocks and bonds? With some renewed upward pressure on bond yields, there's a tug-of-war between nominal R-star (The Fed’s published R* rate plus the current 2-year inflation rate) and monetary velocity. (THREAD)
As you can see above, the 10-year yield is somewhere in between those two. Will monetary velocity pick up and follow nominal R* higher, or will the current inflation spike be transitory and bring nominal R-Star back down? It’s one of the existential questions of the day. /2
My guess is that yields will rise cyclically, but remain in a secular down-trend, driven mostly by demographics. But I do think that inflation will be somewhat higher over the next 10 years than it has been over the past decade, driven by wages and housing. /3
Even so, it wouldn’t surprise me if the correlation between stocks and bonds remains negative, even if we end up getting some non-transitory inflation creep from the labor and housing markets. /4
While there are several asset classes out there that are not correlated to equities (investment grade bonds, gold, bitcoin), only government bonds have provided a negative correlation. /5
So perhaps the 60/40 paradigm will live to see another day. The glory days of investors getting paid to diversify (when bond yields were higher) are likely gone. Now, we pay for protection (through a loss of purchasing power), just like we would for home or car insurance. /6
Nevertheless, if a reduced drawdown during equity-market corrections makes the difference between hanging on and getting out, then perhaps it’s worth it. /END
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