tempts to offset economic downturns with expansionary monetary pol-
icy. This inflationary policy accompanies a weak real economy, such as
occurred during the 1970s. The negative short-term effects of inflation
on equity returns are detailed in Chapter 11.
But this has changed in recent years. Since 1998 there has been a
dramatic reversal in the short-term correlation between stock and bond
prices, as shown in Figure 2-4. Over the past decade stock prices have
beennegativelycorrelated with government bond prices. From 1997
through 2001 the world markets were roiled by economic and currency
upheavals in Asia, the deflationary economy in Japan, and then the
events of September 11.^4 The collapsing currency markets, combined
with falling commodity prices, had an eerie resemblance to the 1930s,CHAPTER 2 Risk, Return, and Portfolio Allocation 31
FIGURE 2–4
Correlation Coefficient between Monthly Stock and Bond Returns(^4) The causes and consequences of these events are discussed in Chapter 10.