NEW YORK CITY: Rising inflation in the United States and around the world is forcing investors to assess the likely effects on both “risky” assets (generally stocks) and “safe” assets (such as US Treasury bonds).
The traditional investment advice is to allocate wealth according to the 60/40 rule: 60 per cent of one’s portfolio should be in higher-return but more volatile stocks, and 40 per cent should be in lower-return, lower-volatility bonds.
The rationale is that stocks and bond prices are usually negatively correlated (when one goes up, the other goes down), so this mix will balance a portfolio’s risks and returns.
During a “risk-on period,” when investors are optimistic, stock prices and bond yields will rise and bond prices will fall, resulting in a market loss for bonds; and during a risk-off period, when investors are pessimistic, prices and yields will follow an inverse pattern.
Similarly, when the economy is booming, stock prices and bond yields tend to rise while bond prices fall, whereas in a recession, the reverse is true.
But the negative correlation between stock and bond prices presupposes low inflation. When inflation rises, returns on bonds become negative, because rising yields, led by higher inflation expectations, will reduce their market price.
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