The correlation is pretty decent but what we can notice now is that there is this gap.
If the bond market is right, we will get a sharp sell-off pretty soon.
If equities are right, bonds will underperform but would that benefit equities? This chart suggests it would only marginally.
To sum up, downside risk appears higher than upside risk. The asymmetry makes me want to increase the defensive allocation.
A positive for equities in the short term: there can be a few months before such imbalances correct. Timing is always the trickier bit.
Correct but this gap may last for long, especially as bond yields are artificially low (thanks to QE2 talks). If QE pushes yields lower and maitains the economy afloat, a low interest rate environment, ultra-loose monetary policy and no double-dip would be the perfect coktail for equities. Don't you think?
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