But things have already changed, and current valuations are much more attractive, suggesting that future returns will improve. Opsal’s hope was resurrected by collapsing equity multiples and rising bond yields, which contributed to a nearly two-point improvement in returns that is “perhaps that best and sharpest short-term improvement in this series since the 1970s,” he wrote. “Not only have valuations produced a tailwind for 60/40 investors, favorable trends in correlations have also helped create an ideal investment environment.”
It’s true that the negative stock/bond correlation seen from the 1990s until recently produced strong diversification benefits between the two asset classes. But that negative correlation has not historically been a permanent expectation, Leuthold Group’s research found. Since 1927, there were more periods when stock/bond correlations were positive.
“The duration of the most recent negative correlation era may have led investors to conclude that bond returns will usually offset stock weakness, but history does not support the notion of ‘negative is normal,’” he wrote.
By looking at various economic factors and reviewing other studies in addition to their own data, Leuthold Group found that stocks and bonds have the same sensitivity to inflation and interest rates, but opposing sensitivity to economic growth and unemployment.
Inflation and interest rates are the main topics of economic discussion today, so it’s correct to see stocks and bonds positively correlated. But when the conversations flip to how well the economy is growing, it’s very likely stocks and bonds will again be negatively correlated., Opsal said.