Below is a pretty simple chart from Morgan Stanley that illustrates a pretty important concept.
Historically, when 10-year bond yields fall below 3% for an extended period of time, stocks and bond yields tend to go in opposite directions (meaning stocks and bonds rise in tandem). That’s more or less been the status quo during the past few years of sub-3% 10-year yields.
The last time bond yields rose above 3% – all the way back in the 1950s, as the chart shows – the correlation went positive. Stocks were rising while bonds were selling off, sending yields higher (think “Great Rotation”).
The problem is that these transitions from one market phase to the next “can be very confusing,” as Morgan Stanley puts it – after all, when correlations flip from negative to positive, they inevitably pass through a range characterised by little or no correlation.
Given the recent surge in stocks and some of the flirtation with rising bond yields we have seen so far in 2013, the correlation chart is worth keeping in mind.