Bonds hedge equities only when inflation is quiet

The idea that bonds rise when stocks fall is one of the most relied-upon assumptions in investing. It depends on inflation staying quiet. When inflation is the thing markets fear, bonds and stocks tend to fall together.

The correlation has regimes

When growth scares drive markets, investors buy bonds as stocks fall, and the hedge works. When inflation scares drive them, rising rates hurt both at once, because higher yields mean lower bond prices and lower equity valuations.

A balanced portfolio built on the first regime can get an unpleasant surprise in the second.

What I'm watching

• The rolling correlation between stock and bond returns
• Inflation expectations, particularly the medium-term measures
• Which data releases move markets most, growth or prices

Where I stand

Flat. The correlation is in transition, and duration is a weaker hedge than it looks until inflation settles.

What would change my mind

Inflation expectations anchoring for several months while growth data softens. That is when the old correlation returns, and duration earns its place as a hedge again.