US Economy: Inflation Will Hurt Both Stocks and Bonds - by Nouriel Roubini

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% of one’s portfolio should be in higher-return but more volatile stocks, and 40% 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. Consider that any 100-basis-point increase in long-term bond yields leads to a 10% fall in the market price – a sharp loss. Owing to higher inflation and inflation expectations, bond yields have risen and the overall return on long bonds reached -5% in 2021.

Read more at: Inflation Will Hurt Both Stocks and Bonds by Nouriel Roubini - Project Syndicate