Indiana Trust Wealth Management
Investment Advisory Services
by Clayton T. Bill, CFA
Vice President, Director of Investment Advisory Services

  • The U.S. equity market, represented by the S&P 500 index, rose 1% this week.
  • The recent rise in interest rates has pushed correlations between stocks and bonds into positive territory, unlike the previous 23 years but very much like the 30 years prior to that.

Fidelity Investments recently noted that three-year rolling correlations between stocks and intermediate U.S. Treasury bonds have moved into positive territory for the first time in over twenty years. At present, when bond prices go up (and yields fall), stock prices tend to go up, and when bond prices fall (and yields rise), stocks tend to fall.


Source: Fidelity Investments Asset Allocation Research, January 2024

Asset classes with low or negative correlations are usually viewed more favorably by portfolio managers. One asset class zigs while another zags, and when those asset classes are combined, the portfolio’s risk profile is lowered. Volatility is reduced.

Will the now-positive correlations between stocks and bonds meaningfully reduce bonds’ effectiveness at dampening stock market risk? Some asset managers are urging investors to seek out “uncorrelated” asset classes, such as alternatives, to mitigate this situation and to strengthen portfolio diversification.

Let us revisit the long period in Fidelity’s chart from roughly 1970 to 2000, when correlations between stocks and bonds were positive. How did a 60% stocks / 40% bonds portfolio perform during that time versus the stretch of years of negative correlations from 2000 to 2023? Did portfolio volatility (measured by standard deviation) fall dramatically once correlations turned negative in 2000?

Volatility barely nudged lower once correlations turned negative in 2000. This is likely because the correlations’ absolute values are not very high, on average, over all these timeframes. One does not need negative correlations for portfolio volatility to be reduced – the value just needs to be below 1.0. Despite correlations turning positive, portfolio volatility is still meaningfully reduced by adding bonds.

This is also true because most of the volatility in balanced portfolio returns is attributable to the equity allocation, not to bonds.  If the concern is reducing stock market risk, correlation does not convey the magnitude of an asset class’s movements with the stock market – only the direction. Intermediate US Treasury bonds barely move at all compared to the gyrations in the stock market. That is true even when considering the last three years of positive correlations, a period which includes 2022 when stocks and bonds fell in concert and in similar magnitude.

At higher levels of interest rates and inflation, stock and bond correlations tend to be positive. Why this is so is subject for debate, but it should not necessarily be viewed as a negative development for a balanced portfolio of stocks and bonds. The recent rise in interest rates was painful to endure in 2022, however forward-looking returns for fixed income have improved dramatically as a result. The best predictor of bond returns are their yields, and yields have risen.

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IMPORTANT DISCLOSURES: All info contained herein is solely for general informational purposes. It does not take into account all the circumstances of each investor and is not to be construed as legal, accounting, investment, or other professional advice. The author(s) and publisher, accordingly, assume no liability whatsoever in connection with the use of this material or action taken in reliance thereon. All reasonable efforts have been made to ensure this material is correct at the time of publication. Copyright Indiana Trust Wealth Management 2024.