Bad News For Investors: This Return-Boosting Trend May Soon Be Consigned To History

Bad News For Investors: This Return-Boosting Trend May Soon Be Consigned To History
Andrew Rummer

almost 3 years ago1 min

The past two decades have provided an unusually benign backdrop for investors, with stocks and bonds exhibiting a negative correlation where losses in one were generally offset by gains in the other. 

As the chart above from money management giant PGIM shows, stock-bond correlations have been lower since the turn of the century than for most of the period from 1950 to 2000 – meaning a classic investment portfolio of 60% stocks and 40% bonds was almost guaranteed to do well.

Unfortunately for investors, PGIM argues in a new report that many of the current shifts in government and central bank policy – from rising budget deficits to governments exerting more control over interest rates – may well push these correlations back into positive territory. 

Greater correlation between stocks and bonds removes a natural hedge in investors’ portfolios and leaves them with an unenviable choice: either accept lower returns or face larger swings in the value of their portfolio (a.k.a. increased volatility). 

Or, to put it another way, rising stock-bond correlations will hit your returns for a given level of volatility. So best hope the 21st century trend of negative correlations continues and we’re not entering a new era following the coronavirus pandemic.

Chart of portfolio returns compared with stock-bond correlations


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