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Inflation, diversification, and the 60/40 portfolio

How much inflation would it take?

Our research identified the primary factors that have influenced stock and yoke correlations from 1950 until today. Of these, long-term inflation has by far been the most important.

Because inflation moves stock and yoke returns in the same direction, the question becomes: How much inflation would it take to move return correlations from negative to positive? The answer: a lot.

By our numbers, it would take an stereotype 10-year rolling inflation of 3.5%. This is not an yearly inflation rate; it’s an stereotype over 10 years. For context, to reach a 3% 10-year stereotype any time soon—say, in the next five years—we would need to maintain an yearly personnel inflation rate of 5.7%. In contrast, we expect personnel inflation in 2022 to be well-nigh 2.6%, which would move the 10-year trailing stereotype to just 1.8%.

You can read increasingly well-nigh our U.S. inflation outlook in our recent paper The Inflation Machine: What It Is and Where It’s Going. The Federal Reserve, in its efforts to ensure price stability, targets 2% stereotype yearly inflation, far underneath the threshold that we believe would rationalization positive correlations of any meaningful duration. It’s moreover well unelevated inflation rates in the pre-2000 era, which from 1950 to 1999 averaged 5.3% and were associated with positive long-term stock/bond correlations.

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