A key market dynamic has flipped: Stocks and bonds are moving in the same direction

·2 min read

Reproduced from S&P Dow Jones Indices; Chart: Axios Visuals

An important dynamic in financial markets has flipped, for now at least.

Why it matters: Stock and bonds are usually inversely correlated — when stocks go up, bond prices move down.

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  • When invested in both, this diversification helps suppress volatility in the value of a portfolio.

  • However, both have recently been moving together in the same direction, making investors' portfolios more susceptible to volatility.

Driving the news: Since May, the six-month trailing correlation has been positive between stocks — as measured by the S&P 500 — and bonds as measured by the 10-Year Treasury note.

  • This happens occasionally for brief periods of time. The last time correlations went positive was in late 2013 during the "taper tantrum," an episode where Treasury yields surged following the Federal Reserve’s announcement that it would be tapering its then quantitative easing program.

The big picture: Over the past 40 years, yields have generally trended lower in what can be characterized as a low-inflation environment.

  • Charles Schwab chief investment strategist Liz Ann Sonders tells Axios this type of low-inflation environment fosters negative correlation because yields moving higher (i.e. when bond prices fall) signals things like improving growth, which is bullish for stocks.

The latest: Today, inflation is the big risk everyone’s talking about.

  • "We don't know whether it's going to be long lasting or transitory," Sonders says. "But for now, we've seen that reversal."

What to watch: Inflation data, like Tuesday’s hotter-than-expected Consumer Price Index report, bear watching over the next few months to see if prices cool off and correlations go back to being inverted.

  • "If indeed, it's a secular shift, that has huge implications for market behavior for how you diversify," Sonders says.

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