April 2024

Market Commentary

Stock and Bond Market Correlations

(4 min read)

Before the period known as the Great Moderation, the 1990s through to the early 2000s, which was characterised by falling inflation from the double-digit levels of the 1970s, globalisation and robust economic growth, the rule of thumb was that when bond yields and interest rates increased to reflect above trend economic growth stock markets performed positively. The opposite, of course, was true that when the economy slipped into recession equities reflected this and underperformed while bonds did well as policy makers reduced interest rates. This was the thinking behind 60% equity/40% bond strategies or balanced portfolios.

Following the 2008 Global Financial Crisis (GFC) when central banks were desperately trying to avoid deflation, interest rates globally remained at near zero for over a decade until the invasion of Ukraine and other geopolitical events changed the backdrop. During the post GFC period, equities and other ‘risk’ assets performed well as markets were rerated as future cashflows and earnings were discounted by very low interest rates. Both bond and stock markets therefore became highly correlated in their performance. Consequently, when interest rates dramatically increased in 2022, all asset classes fell together, and the 60/40 strategy provided little protection.

So where are we now in terms of the potential relationship between different asset classes going forward? The first chart below plots the performance of global equities versus US Treasury/government bonds (the global bellwether for interest rates) going back two years when the US Federal Reserve started increasing interest rates. During the first year from April 2022 both stocks and bonds remained correlated and moved in tandem. The last 12 months looks somewhat different with equities putting in a resilient performance into late summer while bond prices continued their decline. Since the peak in bond yields last autumn equities were super charged by a strong bond rally as the market priced in the end of rate increases. However, in Q1 of 2024 ‘risk’ assets have continued to surge but without the support of bond prices which are broadly unchanged. The observation here is that maybe equities are reacting to the strength and resilience of the global economy, and particularly the US, rather than cheap money forcing liquidity into the stock market.

The second chart hopefully reinforces this possible switch in driver for equity markets. In the first half of the period growth stocks remained highly correlated with bonds and underperformed as bond prices fell.  So called ‘value’ stocks outperformed as expected given the greater resilience to higher interest rates in that sector of the stock market. In the last 12 months, while bonds continued to fall, rise somewhat in the autumn to year end and have remained unchanged so far this year, both growth and value stocks have risen together.

It might just be that we have entered a healthier period where equities are driven more by the prospect of increased productivity due to themes such as AI and the robustness of the economy than by excess liquidity finding itself into the market, even at elevated valuations.

This should make the 60/40 portfolio stance a sounder strategy in the future.

Peter Geikie-Cobb | Head of Investment Research
Montgomery Associates
11th April 2024