Market view: From the desk of CIO Eric Freedman

Moms, Dads and Grads

Early June has a unique and powerful energy to it. In the U.S., high school, college and graduate school ceremonies offer a needed exhale after years of hard work. Graduations also include sage advice delivered by scholars, government officials, celebrities and others, often encouraging new graduates to embrace failure, meander outside their comfort zones, or other reflections as the degree recipients move to the next life stage. My middle daughter just completed her senior year of college, and hearing perspectives from athletes, authors and actresses offered inspiration and timely views. Seeing family reunions on college campuses celebrating collective achievements and sacrifices is nothing short of rejuvenating.

Graduations conjure memories of textbooks, problem sets, papers and other outputs designed to gauge a student’s conceptual grasps. In my classroom days in both undergraduate and graduate school, Finance centered on a range of principles that endured the test of time: the time value of money, the risk/return tradeoff, cash flow as a determinant of value, compound interest concepts, market pricing, incentives, and a host of others. Investment management has its own principles, often grounded in relationships between asset classes demonstrating imperfect correlations, promoting diversification’s powers. When describing the strict tradeoffs inherent in finance and economics, 1930s newspaper editor Walter Morrow famously claimed, “There ain’t no such thing as free lunch.”¹ Diversification through a well-constructed portfolio may prove to be that quote’s exception.

Evolving relationships among asset classes

Despite seemingly long-standing relationships between asset classes, perhaps none is so ingrained or studied as how stocks and bonds can combine to help minimize risk and maximize returns. Harry Markowitz shared the 1990 Nobel Prize in Economic Sciences for his work on portfolio choice which still serves as an asset allocation cornerstone. In describing his work, the Royal Swedish Academy of Sciences cited his portfolio choice theory as a way in which “wealth can be optimally invested in assets which differ in regard to their expected return and risk, and thereby also how risks can be reduced.”² Markowitz emphasized that portfolio choice always occurs with uncertainty, meaning one invests today with uncertain outcomes, so having assets paired together with divergent and low correlations to one another will be additive over time.

But what if the relationships that exist between asset classes become unstable? Figure 1 below shows the long-term correlation between domestic large company stock returns (as measured by the S&P 500 Index) and 10-year U.S. Government Treasury Note returns. Figure 1 includes nearly sixty years of data, spanning events including conflicts and wars, recessions, inflation shocks, economic booms, and large equity market increases and declines.

For those less familiar, the higher/more positive the correlation, the more similar the return histories have been. While analysts and investors disagree about what correlation level provides true diversification, mathematically any correlation below one (1.0 on the chart scale above) offers some level of return divergence between two assets. As you can see, at no point in the rolling data in Figure 1 do we observe a correlation of one, suggesting some correlation benefits between U.S. large company stocks and U.S. Government bonds. Very low, and in some periods negative, correlations contributed to the “60/40” mantra where many asset management and advisory firms utilize a 60% stock and 40% bond mix as a baseline moderate allocation, periodically rebalancing portfolios back to those proportions to perpetuate a durable combination of growth and income.

However, correlations have turned markedly higher in recent time periods. In fact, rolling correlations between U.S. stocks and bonds have never been higher. Investors felt that during the U.S. Federal Reserve's 2022 interest rate hiking campaign, when the central bank jettisoned COVID-era low borrowing costs in reaction to inflation pressures. Stocks and bonds both felt pressure that calendar year, with many questioning if diversification’s powers are vestiges of the past. Further, we have voiced cautious optimism regarding government bonds' forward path and remain on guard for how markets respond to U.S. deficit spending persistence. Irrespective of recent shakiness, U.S. government bonds remain finance’s cornerstone; calls for the dollar to lose its reserve currency status or foreign governments to meaningfully reduce their U.S. government bond holdings appear premature.

Asset class diversification in investor portfolios

With a hat tip to Dr. Markowitz’s notion of investing in constant uncertainty, we continue to build portfolios with a variety of asset classes that extend far beyond stocks and bonds. While we maintain the belief in bonds offering protection against several risk factors while offering income and correlation benefits, narrowly focusing on stocks and bonds alone, especially the too rampant tendency of solely domestic stocks and bonds, is unlikely to help most investors prepare for the combination of risks and opportunities attendant in today’s market. We advocate for a more global view, incorporating asset classes across stocks, bonds, and real assets and within those three categories we drill into granular subcomponents that in some cases look nothing like stocks or bonds. For clients who qualify, a combination of public and private market assets with an eye toward underlying liquidity and of course fees remain of primary focus for us.

Capital market movements thus far in 2025 reflect the wide range of outcomes commensurate with shifts in global trade, policy and election outcomes. Graduation speeches advising an open mind and humility while retaining a principled approach match our asset allocation views. To recent graduates, our very best to you as you hit this next life stage with the energy attendant with this time of year, and to the Moms and Dads behind them, congratulations.