By Daniel McGarvey, CFA on behalf of Stonebridge Financial Group advisors
We have previously brought attention to the increasingly positive correlation between stocks and bonds in recent years, but it can be especially helpful to view this relationship when compared to inflation. In basic terms, positive correlation means that the values of two assets tend to move in the same direction, while negative correlation means they move in opposite directions. Investors typically expect a negative stock-bond correlation because it provides diversification benefits and a downside hedge during equity downturns, but that correlation has historically flipped positive in inflationary regimes. As shown below, correlations were negative throughout most of the 2000s and 2010s when inflation was well under control, but they were substantially positive in decades prior. The chart’s inflation index is the Core Consumer Price Index (CPI), which measures prices changes for goods and services excluding food and energy.
In today’s context, these relationships are important because we might not be out of the woods yet with inflation concerns. It is not rare to see shocks like we experienced in 2022 followed by a second wave years later, and that risk could be more pronounced if we avoid going into a recession. Even without a large second wave, it’s hard to see us returning to a below 2% CPI environment when our government keeps printing money so prolifically and the world continues deglobalizing. In other words, it could be some time before bonds go back to hedging equity risk as well as investors might expect.
An important caveat is that short term bonds are less sensitive to interest rate risk than long term bonds and therefore more likely to act as a portfolio ballast in inflationary regimes. And, in today’s rate environment, they have relatively attractive yields for their lower level of risk. It is also worth noting that the chart above is only looking at 10-year Treasury bonds, but there are many other types of bonds which are affected by factors beyond Treasury rates, such as credit spreads. Flexible active bond managers should be able to find value across the curve and credit spectrum even when inflation is high.
Additionally, positive stock-bond correlation makes a strong case for incorporating alternative investments into allocations. When bonds are unable to provide satisfactory diversification, it becomes more necessary to find that diversification from other less correlated sources.
The S&P 500 continued its impressive post-April run with a 2.3% return in July. The Bloomberg US Aggregate Bond Index fell -0.3% as the FOMC once again chose to hold rates steady and the 10-Year Treasury Rate rose from 4.24% to 4.37%.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
Source of below charts: YCharts, Inc.
August 2025 Commentary: Correlation and Inflation
By Daniel McGarvey, CFA on behalf of Stonebridge Financial Group advisors
We have previously brought attention to the increasingly positive correlation between stocks and bonds in recent years, but it can be especially helpful to view this relationship when compared to inflation. In basic terms, positive correlation means that the values of two assets tend to move in the same direction, while negative correlation means they move in opposite directions. Investors typically expect a negative stock-bond correlation because it provides diversification benefits and a downside hedge during equity downturns, but that correlation has historically flipped positive in inflationary regimes. As shown below, correlations were negative throughout most of the 2000s and 2010s when inflation was well under control, but they were substantially positive in decades prior. The chart’s inflation index is the Core Consumer Price Index (CPI), which measures prices changes for goods and services excluding food and energy.
In today’s context, these relationships are important because we might not be out of the woods yet with inflation concerns. It is not rare to see shocks like we experienced in 2022 followed by a second wave years later, and that risk could be more pronounced if we avoid going into a recession. Even without a large second wave, it’s hard to see us returning to a below 2% CPI environment when our government keeps printing money so prolifically and the world continues deglobalizing. In other words, it could be some time before bonds go back to hedging equity risk as well as investors might expect.
An important caveat is that short term bonds are less sensitive to interest rate risk than long term bonds and therefore more likely to act as a portfolio ballast in inflationary regimes. And, in today’s rate environment, they have relatively attractive yields for their lower level of risk. It is also worth noting that the chart above is only looking at 10-year Treasury bonds, but there are many other types of bonds which are affected by factors beyond Treasury rates, such as credit spreads. Flexible active bond managers should be able to find value across the curve and credit spectrum even when inflation is high.
Additionally, positive stock-bond correlation makes a strong case for incorporating alternative investments into allocations. When bonds are unable to provide satisfactory diversification, it becomes more necessary to find that diversification from other less correlated sources.
The S&P 500 continued its impressive post-April run with a 2.3% return in July. The Bloomberg US Aggregate Bond Index fell -0.3% as the FOMC once again chose to hold rates steady and the 10-Year Treasury Rate rose from 4.24% to 4.37%.
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
Source of below charts: YCharts, Inc.
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