Stocks-Bonds Return Correlation and Inflation

A subscriber asked whether the correlation between returns on stocks and bonds is elevated when inflation is above 5%, such that equities and fixed income offer little diversification protection. To investigate, we calculate the U.S. overall inflation rate from monthly values of the consumer price index over the prior year to find months with the inflation rate over 5%. We then compute monthly total return correlations for the following two pairs of funds when inflation is above or not above 5%:

1. Fidelity Fund (FFIDX) and Fidelity Investment Grade Bond Fund (FBNDX).
2. SPDR S&P 500 ETF Trust (SPY) and iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD).

Using monthly dividend-adjusted prices for FFIDX and FBNDX since January 1980 and for SPY and LQD since July 2002, all through September 2022, we find that:

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