Forecasting the stock-bond correlation

The stock-bond correlation can be measured and predicted using macro variables. This is helpful for any portfolio construction. If we can predict the direction of the stock-bond correlation, we can adjust the overall risk of the portfolio across asset classes. In a more obscure paper, "The Stock-Bond Correlation", the authors compare several approaches for predicting this key correlation and find that a combination of fundamental variables with filtering does an effective job.

The key variables for predicting the stock-bond correlation include: economic growth using industrial production, inflation, relative yield of stocks and bond, and relative volatility of stock and bond yields. The authors use partial sample regression to better support their analysis.

The conclusion is that fundamental data can add to stock-bond predictions and improve forecasts over simple extrapolations. Investor don't have to fly blind on this key correlation.