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High Stocks-Bonds Correlation is Not Unusual

A few charts in financial blogosphere show high stock-bonds correlation this year but this isn’t unusual since in the 90s stocks and bonds were highly correlated.

The 0-lag, 90-day correlation of S&P 500 and 10-Year Note futures since 1982 is shown below.

The correlation started rising in July of last year and it’s currently at +0.45. This is high positive correlation and far from what the market has seen in the last 20 years but it’s not usual as the chart shows.

Specifically, in May 1994, the correlation reached as high as +0.74. In fact, from 1982 to about 2000, the 1000-day moving average of the 90-day correlation was above +0.2 but after 2010 has stayed below -0.30.

Although high positive correlation is not unusual as some analysts may think, it poses risks to passive stocks/bonds allocations and especially to long-only risk parity in case stocks enter a bear market and yields rise. On the other hand, a high correlation is highly desirable when both stocks and bonds are uptrending.

Both extreme scenarios described above have low probability but falling stocks and bonds environment poses significant risks to passive investors and further diversification may be prudent decision at this point. No one knows what will happen because the financial system is highly complex and unpredictable especially in the medium term.

However, I suspect gold and commodities aren’t a good hedge at this point but this is my opinion now and can change depending on new information.

Disclaimer:  No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.

Charting and backtesting program: Amibroker. Data provider: Norgate Data

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