FAST FIVE: JPMorgan Finds The Fed Has Broken The Most Fundamental Market Correlation
In other words, while the low – or inverse – correlation between stocks and bonds has been one of the core anchors of modern finance, allowing cross-asset traders to diversify excess equity risk into bonds, this “basic premise” of modern portfolio consutrction theory no longer works.
According to the JPM strategist, there are several drivers: First, the unusual dynamic that stocks are doing very well at the same time that UST yields have declined.
This, in JPM's view, “is the result of so much QE-driven liquidity in the market that investors are buying everything: stocks and bonds.” The second, less likely, driver of persistently elevated correlations according to Beinstein, is exceptionally strong corporate earnings which have driven further total return gains this year alongside higher equities.
As Beinstein (somewhat sarcastically)concludes, “the potential implications of these developments are interesting” and explains: “traditionally portfolio theory says that bonds are a diversifier for equity market investments.
This has not been the case recently, with the risk that it also remains not the case if/when there is an equity market selloff.” Translation: in the next crash, everything will go down at the same time and there will be nowhere left to hide.