Investors are often told to avoid “putting all their eggs in one basket” by allocating across stocks and bonds. The theory is simple: when equity markets struggle, fixed-income assets may help offset some of the damage. This may have served them during the long years of ‘secular stagnation’ of record low growth and interest rates. Yet, this strategy relied upon a core assumption about how markets behave which we find isn’t always true.
In the context of economic ‘regime’ change (moves between specific market environments characterised by distinct macroeconomic, financial and geopolitical conditions over a set period) to ‘secular reflation’, what can investors do instead?
The diversification trap
The traditional multi-asset 60:40 approach to the investment cycle is that allocations to core asset classes are expected to outperform at different stages. At these times, it may make sense to own equities and higher yielding assets to cushion against the steady interest-rate rises investors can expect.
In contrast, after an economic downturn, fixed income may offer the steady stream of capital investors need.
But this approach relies on a key assumption: that the correlation between equity and bond prices is always low. It ignores one key variable: inflation.
Enter inflation
We find that analysing the impact of inflation can be highly disruptive to this view. As part of Man Group’s proprietary research, our team looked at the relationship between:
- the level of core inflation and;
- the correlation between equity and bond prices
We found that when core inflation persists at around 3% per year, the correlation between equities and bonds has historically switched from negative to positive, on average.
When inflation is above 5%, equity multiples (the measure of total return an investor has made on their initial investment) tend to compress significantly.
That means, if equity markets wobble during a period of moderate to high inflation, investors can’t necessarily rely on their bond allocation to provide portfolio stability.
Just look at 2022, when equity and fixed income assets both suffered significant losses at the same time.
Where are we now?
According to our analysts, we may now be approaching a period of ‘regime change’, or at least recalibration. After more than 30 years of secular stagnation, we saw a sharp spike upwards in inflation in 2022, and correlations turned positive – as the chart below illustrates.
Figure 1. US and UK long-term stock-bond correlation. Trailing 10 years, monthly periodicity
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Source: GFD, Bloomberg, Man Group. As of May 2025.
Past performance is not an indication of future returns.
To recap, secular stagnation happens when too great a volume of savings chases too few investment opportunities. Yields (including inflation as, effectively, the yield on everything) then fall (as they did, cycle by cycle, from 1981 to 2020). This makes saving less attractive, and investment more so.
The current cycle (‘secular reflation’) is the first one we have seen in 35 years where peak rates exceed the top of the prior cycle. The next 35 years may well continue this trend of increasingly higher peaks and troughs. This is partly because savings may become more restricted. Constraints in their magnitude could emerge as the world ages, and in their velocity, as financial repression becomes more acceptable in developed markets. But mainly, the world’s investment requirements are increasingly massive.
It may now be that planned investment will consistently exceed planned saving. This is the opposite arrangement to secular stagnation and threatens to break the negative stock-bond correlation that multi-asset investors have enjoyed over the past two-and-a-half decades.
Our base case scenario suggests inflation may remain above 3%, and stock-bond correlation stay above +0.2 (on a smoothed basis). That could also mean semi-regular levels of above 5% inflation, with the consequent multiple compression.
What investors might consider instead
True complementarity is achieved from different approaches and asset classes. An adaptive multi-asset approach may benefit from offering maximum diversification and low correlation to traditional assets – both equities and bonds.
It should also offer a track record showing consistent years of performance across market cycles. In our strategy, we carefully combine different approaches to deliver a portfolio that aims to perform in a broad range of market conditions. To do this, we have the full support of Man Group’s 1,300 resources across Finance, Technology, Product Development, Legal and Compliance.
With three decades of experience in developing systematic trading methodologies, we blend the best of quantitative and discretionary approaches to offer investors a wider mix of return streams, rather than just different asset classes.
So investors can have greater confidence that their portfolio is being carefully managed, whatever market regime we’re in.
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