Negative Stock-Bond Correlation Won't Last Forever

The study found that stock-bond correlation is reliably associated with interest rate volatility, the co-movement of economic growth and interest rates and the co-movement of equity and bond risk premia.

PGIM calls these economic conditions “symptoms” of the underlying macro environment, which at the end of the day relates to monetary and fiscal policy and broad economic shifts.

If a shift to positive correlation should occur but all other factors remain equal, chief investment officers will face a tradeoff between maintaining existing risk targets, reducing their stock allocation and lowering expected returns, versus maintaining existing return targets and accepting higher volatility and lower risk-reward characteristics — though in history all else is rarely equal, PGIM says.

The study says chief investment officers should be attuned to macroeconomic policy shifts that may signal a change in regime. 

It notes that continued low interest rates by themselves may be insufficient to support the current negative stock-bond correlation. Depending on the macroeconomic policy environment, low interest rate scenarios with positive stock-bond correlation may emerge. 

CIOs with strong macroeconomic policy views may want to use the study’s findings to translate those views into an expectation for stock-bond correlation, according to the study. For those without strong views, PGIM advocates a zero correlation expectation, which it says will produce a prudent risk assessment.