The negative bond/positive stock return of 2021 - will it continue?

 

There is a trade-off between stocks and bond returns. For the entire post-GFC period, the return correlation between these two has been negative, yet generally, both assets generate positive returns in any given year. The stock-bond asset allocation mix provides diversification with limited cost - the pain from holding bonds is limited.

While negative returns for both asset classes have been the exception (2015, 2018), there have been a few years when stock returns have been positive and bonds negative. The poor bond performance in 2013, 2015, 2018, and 2021 has a lot to do with the low yield for bonds in a zero-rate environment; however, except for 2021, these years were also low inflation periods.  

The question is what quadrant the stock bond mix will fall in 2022. A lot has to do with the expected macro environment. Make a call on the environment and you will likely know return performance. Similarly, make a call on return performance and you are implicitly making a call on the global economic environment. Given these quadrant probabilities and you have a reasonable and measurable framework for predictions. 

Quadrant I is the beautiful policy mix of liquidity and fiscal stimulus with and end of COVID and increases in global productivity. It is what we would like, but seems unlikely from current macro data. Quadrant II is the mild world status quo. COVID peaks in the winter and then retreats. Fed monetary policy follows a careful glide path and global fiscal policy provides downside protection albeit at lower levels. Stocks will do well, but bonds have headwinds from current high inflation levels and excessively low real rates. Quadrant III suggests policy mistakes from central banks - either tightening too fast or not fast enough. Quadrant IV is slower growth from continued COVID, limited fiscal response but continued dovish monetary policy and elevated inflation albeit without the extreme disruptions. 

These are simple sketches on possible environment but using the quadrants as a map for return performance is a simple way to address the return environment potential.