Rising Correlation Between Stocks And Bonds Is A Serious Risk
And Makes Me Even More Bearish On Treasury Bonds
(My opinions only. Not intended to be investment advice. Full disclosure — I own put options on TLT)
An under-appreciated risk is the rising correlation between stocks and bonds. This is of course a result of inflation fears driving interest rates up, which on the margin hurts both stocks and bonds. The higher the blue line in the plot below goes, the less bonds hedge stocks, and the higher the risk of a supposedly diversified portfolio becomes (Treasury bonds are the primary diversifier).
If stocks and bonds become positively correlated, it removes yet another reason to own bonds. Who would want bonds when they yield nothing after inflation, have tremendous risk to the downside, and provide no hedging benefits? This is a real risk that we all need to think through, not just asset managers — for example, many 401Ks and target date funds own a decent amount of Treasury bonds for diversification.
