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The balanced approach

One of the pillars of wealth management is the balanced portfolio, comprised of stocks and bonds, due to its good historical risk adjusted returns. The basis of the strategy, as its name indicates, is the combination of two asset classes that have different behavior, providing more stability that if you were to choose each one separately. But for the strategy to work, the correlation between both asset classes has to be low or negative, otherwise the strategy may have great years and bad years, but it would not provide a balanced result. As you can see in the chart below, both the 10 yr treasury yield and the S&P500 have moved in unison since August, lowering the effectiveness of the strategy. These episodes of high correlation have happened in the past and they may have to do with high levels of euphoria or panic, pushing everything up or down, irrespective of their valuations or characteristics. The strategy needs a market event that triggers the separation of both, decreasing correlations and increase its effectiveness again.

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