A long-term look at the US stock/bond correlation shows that there have been long period of both positive and negative correlation. These dynamics exist even though a good working hypothesis is that this correlation should be positive. A change in short-term interest rates should impact the valuations for stocks and bonds in the same direction through present valuing of cash flows. In reality, the key issue affecting correlation is the level and volatility of inflation.
When inflation is high, the short-term discounting factor which includes expected inflation seems to dominate the stock/bond correlation. When inflation is low and thus short rates are low, other factors such as economic growth seem to dominate and growth will have an negatively impact on the stock/bond correlation. A further review suggests that these inflation regimes will be associated with monetary policy.
The monetary regimes will respond to inflation and create a different correlation environment as measured by the Taylor Rule.
Extrapolating this historical information suggests that the combination of restrictive monetary policy in a higher volatility environment will tilt diversification risks to higher correlation. It is unlikely that there will be a significant inflation risk shift in the near-term, but our priors suggests that investors will not continue to receive the diversification tailwind that was the great portfolio risk reducer in the post Financial Crisis period.
Some past posts on the issue: