I’m curious about your first point. If stock-bond correlations have been negative for much of recent history, why do you place so much emphasis on portfolios being prepared for that relationship to flip?
Are there particular economic indicators or market conditions that would make you think a shift back to a positive correlation is becoming more likely? Or is the idea simply that investors should always account for that possibility, even if the odds seem low?
You can think of a stock-bond correlation flip as analogous to a "rare disaster." For risk averse investors (like most of us!), even a small probability of an adverse event can impact our behavior. Many investors who were near retirement or who had just retired in 2022 spent most of their investing life in a period during which the stock-bond correlation was strongly negative. Their portfolios likely reflected this, as most Target Date Funds were developed in the early to mid 2000s. For them, a switch in the stock-bond correlation from negative to positive likely came as quite a painful surprise.
So given that it can happen, risk averse investors would likely benefit in terms of welfare from taking this possibility into account when constructing their portfolios.
I’m curious about your first point. If stock-bond correlations have been negative for much of recent history, why do you place so much emphasis on portfolios being prepared for that relationship to flip?
Are there particular economic indicators or market conditions that would make you think a shift back to a positive correlation is becoming more likely? Or is the idea simply that investors should always account for that possibility, even if the odds seem low?
You can think of a stock-bond correlation flip as analogous to a "rare disaster." For risk averse investors (like most of us!), even a small probability of an adverse event can impact our behavior. Many investors who were near retirement or who had just retired in 2022 spent most of their investing life in a period during which the stock-bond correlation was strongly negative. Their portfolios likely reflected this, as most Target Date Funds were developed in the early to mid 2000s. For them, a switch in the stock-bond correlation from negative to positive likely came as quite a painful surprise.
So given that it can happen, risk averse investors would likely benefit in terms of welfare from taking this possibility into account when constructing their portfolios.