This article is a guest contribution by James Paulsen, Chief Investment Strategist, Wells Capital Management.
A New Inflation-Expectations Monitor!??!
Inflation expectations are constantly monitored by both investors and economic policy officials. Stock and bond investors have long feared potential inflationary risk and the Federal Reserve always faces a decision either to lean toward growth or against inflation.
There are many popular inflation-expectation gauges including those implied by TIP bond prices, yield curve movements, and inflation surveys. However, another has emerged in recent years (the correlation between the daily movements of the stock and bond markets), which is not widely followed nor fully understood, but which nonetheless seems importantly tied to perceptions of inflation, to the efficacy of economic policies, and to the impact of rising interest rates on the stock market. Investors and policy officials should monitor the message of the “Stock/Bond Correlation!”
Stock/Bond Correlation???!
Exhibit 1 illustrates the trailing six-month rolling correlations since 1968 between the daily percent changes in the S&P 500 Stock Price Index and daily changes in the ten-year government bond yield. Correlation coefficients range between +1 (both variables move directly and perfectly together) and -1 (both variables move perfectly inversely to one another), and a coefficient near zero implies the variables mostly move independently.
Exhibit 1
Trailing Six-Month Rolling Correlations of Daily
Percent Changes in S&P 500 Stock Price Index and
Daily Changes in the Ten-Year Government Bond Yield
