6/21 QuickTake intro

Andy Sparks and Juan Sampieri

June 21, 2022


The sharp rise in inflation over the past year and a half, combined with growing concern over the U.S. economy’s strength, may prompt investors to rethink basic assumptions underlying portfolios comprised of bonds, equities and other asset classes.

As shown below, major stock sell-offs (defined as monthly returns below -2%) since September 2021 coincided with sell-offs in Treasurys. By contrast, in the prior two decades, equity sell-offs tended to occur with Treasury rallies. Stated otherwise, bonds’ stabilizing influence in multi-asset-class (MAC) portfolios has been less apparent in the recent data. This calls into question the diversification benefits of balanced portfolios, including the popular 60%-equity/40%-bond strategy.

Investors may be further unsettled by observing that the recent Treasury-equity co-movement is similar to that during the Great Stagflation, between 1978 and 1982, when large equity sell-offs tended to coincide with sell-offs in Treasurys.


The beginning of a new era?

Investors trying to project future co-movements between bonds and equities now face the challenge of interpreting the historical data, identifying drivers and projecting potential paths of growth and inflation.

The Federal Reserve’s actions might also play an important role. During his June 15 remarks, Fed Chair Jerome Powell underscored the Fed’s intense focus on reducing inflation and expressed satisfaction that the tightening of financial conditions over the past seven months is healthy and will continue to temper growth and bring demand into better balance with supply.

Can the Fed affect the bond-equity relationship? The Fed’s credibility with market participants may be the key.1 A vigilant Fed bringing down market inflation expectations could help restore the role of bonds as diversifiers in MAC portfolios, tending to rally when equities sell off.


Are bonds still an anchor, or just added dead weight?

The chart shows periods of market history when bond and equity returns were positively correlated — i.e., moved in the same direction — and hence when bonds didn’t provide diversification. For much of the last two decades, bonds rose in value when stocks fell. Recently stocks and Treasurys have fallen together, as also occurred during the Great Stagflation from 1978 to 1982, shown on the left side of the chart.

Treasury return is computed using the 10-year constant-maturity Treasury yield, retrieved from the Federal Reserve Bank of St. Louis’s FRED database. Equity return is from the MSCI USA Index. U.S. realized inflation is the personal-consumption-expenditures price index, excluding food and energy, from the U.S. Bureau of Economic Analysis.


1In MSCI's macro-finance model, elevated supply-side risk induces a negative inflation-growth correlation and may result in a positive return correlation between stocks and bonds.

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