A tale of two markets

Higher structural yields and concentrated equity gains are making conventional stock-bond diversification less reliable.

• The 30-year US Treasury yield reached 5.63% in early October, up from 4.96% at the end of June, implying an approximately 10% price loss for investors who bought then.
• The S&P 500 and Bloomberg US Aggregate Bond Index reached a three-month rolling correlation of 0.70 in June, while only 29% of S&P 500 stocks were above their 50-day moving average on 6 October.
• Higher yields reflect 3.4% PCE inflation, US federal debt above $40 trillion, a 65-basis-point rise in France's 10-year yield during September, and possible Treasury selling by Japan.
• Expected AI-related investment-grade issuance of around $300 billion could have added approximately 15 basis points to long-dated US yields, while the S&P 500's forward earnings growth expectation is about 17% and its equity risk premium has effectively disappeared.
• Global equity issuance was around 79% above the previous year's level, and GMO estimates that a shift from roughly 1% annual supply contraction to nearly 5% growth could leave returns around 20% below average over the next 12 to 18 months.

Takeaway: Investors should consider shorter-duration Treasuries, inflation-linked bonds and infrastructure exposed to AI-driven electricity demand, while recognizing that a recession could cause stocks and bonds to fall together and limit the protection offered by diversification.