About a year ago we wrote about Inflation Regimes and Return Distributions. The piece referenced an excellent chart we first saw from Goldman Sachs showing the Equity/Bond correlation vs realized US CPI. The negative correlation in the period since the late 1990s occurred in a world of low and stable inflation. The prior period in the chart, from 1970 to 1998 showed a period of higher than target inflation and a steadily positive correlation of stocks and bonds. Many portfolio strategies have been built with this negative correlation as the bedrock. It worked as the dual mandate acted like a single mandate on unemployment- the inflation side of the mandate could be safely ignored. Economy weakens, equity markets weaken, Fed cuts rates, bonds rally. Became self-fulfilling for a long period of time.

When inflation came back with a vengeance driven by pandemic supply chains getting overwhelmed with fiscal and monetary stimulus, then exacerbated by geopolitics and war, stocks and bonds fell together, partly as the starting point for yields was so low and durations so high. It depends exactly where you draw your lines, but long duration bonds – a diversifying asset relied upon to cushion equity markets – hit a drawdown approaching 50%. Traditional portfolios, built on that bedrock regime, only had one side of the distribution in one asset class to help diversify stocks – positive bond returns.

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