MW The 'everybody loses' scenario: Why the Iran conflict is breaking this classic portfolio strategy
By Jamie Chisholm
Shifting correlations are a problem for investors, says Morgan Stanley
The Strait of Hormuz near the Iranian coast is a chokepoint for the transport of energy from the Persian Gulf. Morgan Stanley says the crisis is triggering correlation problems that could be trouble for lots of investors.
Every now and then a particular asset is afforded greater heft than usual in determining broader market machinations. Right now, it's oil.
As the war against Iran compromises supplies of crude, traders are adjusting valuations across asset classes seemingly with every tick of Brent futures (BRN00).
But the current dynamic poses a big problem for investors, according to a team of strategists at Morgan Stanley led by Serena Tang. That's because the latest oil price surge is shifting correlations in the traditional portfolio of 60% equities and 40% bonds.
The 60/40 portfolio is designed to provide growth from stocks and income from bonds. It's considered relatively stable because if equities fall as a result of an economic downturn, for example, that would normally boost the price of bonds.
However, in a note published Thursday, the Morgan Stanley team observe that this week there have been occasions when the jump in oil prices saw both equities and bond prices fall. Bond prices move inversely to yields.
That dynamic occurred because oil prices were surging as geopolitical risk hit supplies and not because of hopes stronger economic growth will boost demand. Higher energy costs may boost inflation, making bonds less attractive.
"The 'classic' negative correlation between stock and bond returns is underpinned by the 'traditional' relationship of growth and inflation traveling in the same direction: stocks offset losses in bonds as growth rises alongside inflation, and vice versa," says Morgan Stanley.
The prospect of surging oil prices causing growth and inflation to shoot in opposite directions reminds Morgan Stanley of what happened to 60/40 portfolios coming out of the COVID pandemic.
"Back in 2021-2023, bond markets that were worried about inflation could not offset losses in equities, which were concerned about growth. Everyone loses in that scenario," they say.
Back then 60/40 portfolios had the worst annual performance in nearly a century, according to Morgan Stanley, and the bank says it is still having conversations with investors scarred by the experience and who ask if bonds really work as diversifiers.
"Those discussions almost always begin with the question, 'Are correlations broken?' That question has now reared its ugly head again," they say.
So, what should investors do to mitigate this correlation shift? Morgan Stanley notes that the short-duration Treasury correlation with stocks is still in traditional negative territory. Indeed the 12-month rolling correlation with the 2-year note BX:TMUBMUSD02Y and equities is "extremely negative" right now compared with the last three years.
However, negative correlations between 30-year Treasurys and stocks are much less pronounced. This partly reflects investors shifting from seeing longer-duration U.S. bonds as a safe haven to more of a risk asset amid policy uncertainty, according to Morgan Stanley.
It means the gap between 2-year Treasury and 30-year Treasury correlation with U.S. stocks has stayed wide for a while.
The challenge for investors right now, says the bank, is that higher oil prices are pushing up the short-duration bond yields more than longer-duration yields. That's "leading to a bear-flattening [of the yield curve] - a reflection that inflation fears are in the front seat while concerns around U.S. policy uncertainty take a back seat," they say.
"Whether shorter-dated bonds or longer-dated bonds function better as a diversifier from this point would depend on which of these worries will win out over the medium term," Morgan Stanley concludes.
The markets
U.S. stock-index futures (ES00) (YM00) (NQ00) are lower as benchmark Treasury yields BX:TMUBMUSD10Y rise. The dollar index DXY is down, while gold futures (GC00) are trading around $5,100 an ounce.
Brent crude futures (BRN00) rose above $87 a barrel, the highest since the summer of 2024, after Qatar's energy minister warned the Middle East war could stop energy exports from the region within days and push prices to $150.
Key asset performance Last 5d 1m YTD 1y S&P 500 6830.71 -1.13% 0.48% -0.22% 19.03% Nasdaq Composite 22,748.99 -0.57% 0.92% -2.12% 25.90% 10-year Treasury 4.173 22.10 -4.40 0.10 -12.80 Gold 5097.8 -3.75% 2.19% 17.67% 74.72% Oil 83.89 24.67% 32.11% 46.12% 25.12% Data: MarketWatch. Treasury yields change expressed in basis points
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The buzz
The U.S. nonfarm payrolls report will be published at 8:30 a.m. Eastern. Economists expect 50,000 jobs were added in February, down from January's 130,000. The unemployment rate is expected to dip from 4.4% in January to 4.3% last month.
Other U.S. economic data due Friday include retails sales at 8:30 a.m. and business inventories at 10 a.m.
Shares of Marvell Technology $(MRVL)$ are jumping after the chip maker topped revenue and guidance expectations.
Gap shares $(GAP)$ are falling after the clothes retailer's outlook for the year disappointed investors.
Fed officials making comments include San Francisco Fed President Mary Daly at 10:15 a.m. and Cleveland Fed President Beth Hammack at 1:30 p.m.
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The chart
Source: BTIG
Until the final hour of Thursday's regular session it looked like the S&P 500 was finally going to close meaningfully below its 6,800 to 7,000 corridor for the first time in three months. But the stock barometer rallied yet again to finish back within the channel. It's a remarkably tight range for such a long period of time. "Ultimately our view remains the same as earlier this week that we should be forming a bottom, but should semis remain heavy and SPX lose 6700, a test of the 200-day moving average (6578) would be a high probability," says Jonathan Krinsky, technical strategist at BTIG.
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Ticker Security name NVDA Nvidia TSLA Tesla TSM Taiwan Semiconductor Manufacturing GME GameStop PLTR Palantir Technologies AMD Advanced Micro Devices MSFT Microsoft AMZN Amazon.com MU Micron Technology AAPL Apple
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March 06, 2026 06:44 ET (11:44 GMT)
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