We show in Exhibit 1 the average inflation adjusted (real) returns delivered by various asset classes over these inflationary periods.US equities (the FT Wilshire 5000) have delivered an average real return of 3.2%, delivering positive returns in 4 of the 6 inflation pulse periods.
Exhibit 1: Average real asset class returns delivered over the 6 periods of rising inflation since 1978
*Data only available from 1997
Source: Wilshire, Refinitiv and Factset. Data as of July 14, 2023
There have been two inflation and real return regimes since 1999
Exhibit 2 compares the real returns achieved in the 10 years prior to the Global Financial Crisis (where inflation averaged 2.9%) with the post Financial Crisis returns (2009 - 2019). In the pre financial crisis period, equities delivered negative real returns while US 10 year bonds delivered positive real returns. This displays a negative correlation between the two key asset class returns.
In the post GFC period marked by accommodative monetary policy, quantitative easing and financial repression, all asset classes posted positive real returns led by Private Equity and the FT Wilshire 5000. Equity/Bond return correlations had become positive.
Exhibit 2: The real asset class returns in the Pre and Post GFC regimes
*Data only available from 1997
Source: Wilshire, Refinitiv and Factset. Data as of July 14, 2023
There have also been two distinct correlation regimes since 1999
Exhibit 3 plots the correlation of asset class returns to the US 10-year bond yield over both the pre and post GFC regimes. In the ten years prior to 2008, equity returns moved in line with bond yields reflected by the 49% positive correlation. This reflects the notion that 'what is good for bonds (falling yields) is bad for equity returns' and vice versa. This correlation relationship was a key driver behind the 60/40 equity/bond construct.
In the post GFC period the equity return /bond yield had turned negative reflecting a persistent decline in yields coinciding with extremely strong equity returns (see Exhibit 2). This has become the correlation regime many models and market participants have become anchored to. A key question for asset allocators is what correlation regime markets are moving to?
Exhibit 3: The two regimes of asset class correlations to bond yields
Source: Wilshire, Refinitiv and Factset. Data as of July 14, 2023
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