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Stock drawdown chart9/12/2023 ![]() ![]() This was mainly driven by skyrocketing prices of energy, coupled with loose monetary and fiscal policies. The 1970s were characterized by stagflation, a condition simultaneously featuring high inflation and stagnant economic growth. This sentiment caused the selling of bonds and buying of equities, further fueling the negative correlation.Įxamining the left side of the chart, a different story can be told. At the same time, long periods of low bond yields contributed to a view that there were no alternatives to equities. This allowed bond prices to appreciate as equity prices declined, resulting in negative correlations between stock and bond returns. During times of equity market stress, it was widely expected that the Fed would step in to ease financial conditions with lower interest rates and quantitative easing. Beginning with Federal Reserve (Fed) Chair Alan Greenspan, investors came to rely on the Fed Put. I would argue that the monetary policy of this era had a great impact on this relationship. This allowed the bond allocation to serve both of its purposes for the portfolio, dampening volatility and protecting against drawdowns. Besides a detour into positive territory between 20, driven by the 2007-08 Great Financial Crisis, stock and bond returns were negatively correlated for long stretches of time. The two-decade-long period between 20 provided the perfect environment for the 60/40 portfolio to prosper. Interestingly, beginning in 2021, correlations have become persistently positive again. This 20-year period saw the rise of the 60/40 portfolio as a popular long-term asset allocation strategy. Beginning in 2000, we entered a 20-year period of persistently negative correlations, with some brief forays into positive territory. Before the year 2000, the correlation between stocks and bonds was persistently positive. The chart depicts two clear correlation regimes throughout time. A similar correlation pattern is seen in the data if shorter or longer windows are chosen. This method was chosen in order to reflect the relatively long-term bias of 60/40 investors. Correlations are calculated using a rolling 36-month window, allowing three years of monthly data to be considered at a time. Aggregate Bond Index, calculated on monthly data, from January 1976 until May 2022. This week’s chart presents the correlation between the total returns of the S&P 500 Index and the Bloomberg U.S. This large discrepancy begs the question - what is happening? In today’s Chart of the Week, I will attempt to put the correlation between stock and bond returns, a large driver of the protective benefits the 60/40 portfolio is intended to provide, into historical context. If return expectations were calculated using the average return correlation from the last 20 years of -9.0%, the expected loss on the portfolio would have been 12.3%. Aggregate Bond Index would be experiencing a loss of 18.2%. However, as of June 14, an investor with a 60% allocation to the S&P 500 Index and a 40% allocation to the Bloomberg U.S. The basic idea is that allocating to bonds will reduce overall portfolio volatility, while also providing a buffer against drawdowns in the equity market. A hot topic for investors in 2022 has been the weak year-to-date performance of the 60/40 portfolio, which involves allocating a portfolio to 60% stocks and 40% bonds.
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