Correlation of stocks and bonds during different inflationary environments
Source: Bloomberg Finance, L.P. and FS Investments, for the period from January 1976 through November 30, 2022. Inflation as defined by the Consumer price index, measured on a rolling 4-year basis. Stocks represented by the S&P 500. Bonds represented by the Bloomberg U.S. Aggregate Index.
- This week brought another dose of good news on the inflation front as Tuesday’s consumer price index (CPI) release saw the second consecutive downside surprise.
- The details of the report were promising as core goods inflation has been negative each of the past two months while leading indicators point to smaller gains in services inflation in 2023.
- Wage growth, however, continues to run at levels much higher than what is consistent with a 2% inflation target, and Fed Chair Powell again emphasized the tight labor market in his press conference as a primary concern regarding services prices.
- Against a backdrop of slowing but still-elevated inflationary pressures, the high correlation between stocks and bonds that doomed the traditional 60/40 portfolio’s diversification benefits in 2022 could remain in place well into the next year
- The chart highlights the correlation between the S&P 500 and the Bloomberg U.S. Agg across various inflation environments. As it shows, the indexes have been positively correlated 100% of the time since 1976 when inflation ran at 4% or higher as it has throughout 2022.1 When inflation averaged between two and four percent, a range it could moderate to in 2023, correlations were still positive nearly two-thirds of the time.1
- Investors may be wise to seek alternative sources of income and total return as they could continue to be disappointed by the potential diversification benefits of the traditional 60/40 portfolio given a changed inflation and policy environment.