The problem with a 60/40 asset allocation - correlation

The investment world has lived on the glory of the 60/40 stock/bond asset allocation. The driver for the success of this approach has been simple. A low or negative correlation between stocks and bonds made bonds a safe  asset to offset the risk exposures in stocks. It also had the characteristic of being less volatile than stocks. This blend makes perfect sense except for the two simple assumption that have turned wrong. The negative stock-bond correlation has moved up. The safe asset of bonds has not been so safe in terms of risk.

The chart shows the rolling 30-day correlation between January 2013.  The correlation between stock and bonds has been highly variable but generally negative. The correlation recently has shown a steep rise. The recent decline in correlation has occurred because of the decline in bonds without a corresponding decline in stocks. The trend in correlation has still be up as measured by a simple moving average.

The 60/40 blend has worked well in the past but that does not ensure that it will work well in the future. The simple allocation mix may not be the best alternative in a changing financial world.