# Stock-Bond Correlation

Source: https://www.yieldcurve.pro/learn/stock-bond-correlation

The **stock-bond correlation** measures whether equity and Treasury bond returns move together (positive correlation) or in opposite directions (negative correlation). It is the single most important parameter in multi-asset portfolio construction.

Historical regimes:

- **1960s-1990s**: predominantly positive correlation. Rising inflation drove both stocks and bonds down; the "Fed model" of equity valuation tied stock prices to bond yields.
- **2000-2021**: predominantly negative correlation. Growth shocks dominated — bad economic news pushed stocks down and bonds up (the "flight to quality" response).
- **2022-present**: correlation turned positive again as inflation re-emerged as the dominant risk factor, simultaneously hurting both stocks and bonds.

The blog series "Is Gold a Stock-Bond Diversifier?" (Parts 1-4) and "The End of the Hedge" provide extensive analysis of this relationship:

- When **growth risk dominates**, correlation is negative (good for diversification)
- When **inflation risk dominates**, correlation is positive (diversification breaks down)
- The transition between regimes is gradual and detectable through rolling correlation analysis

The sign and magnitude of the correlation has direct implications for:

- **[60/40 portfolio](https://www.yieldcurve.pro/learn/60-40-portfolio) effectiveness**: negative correlation is necessary for bonds to hedge equities
- **Optimal portfolio weights**: the equilibrium allocation to bonds increases when correlation is more negative
- **Risk budgeting**: the portfolio's risk changes dramatically depending on the correlation regime
- **Asset pricing**: the required term premium on bonds depends partly on their hedging properties