The case for a 60/40 stock and bond portfolio largely rests on one assumption: when stocks fall, bonds rise and cushion the blow. This week’s Chart shows how conditional that assumption really is. It shows the rolling 24-month correlation between stocks and bonds going back to 1975. Above zero, the two move together. Below zero, they offset each other, which is the behavior a classic 60/40 portfolio is counting on.
Notice how the sign periodically flips. From 1975 through the late 1990s it was mostly positive. Around 2001 it went negative and stayed there for two decades, the era that seemingly built the 60/40’s reputation, with bonds rallying while equities fell in 2000-02, in 2008, and in 2020. Since 2022 it has snapped back to positive.
It’s tempting to explain this with the level of inflation: high inflation in the 1970s and 80s, low inflation after. That story doesn’t really hold. Inflation fell steadily through the entire 1990s, from 5.4% in 1990 to 1.6% by 1998, and the correlation stayed positive the whole time. The level of inflation is not the switch.
What flips the sign is the relationship between inflation and growth, which essentially comes down to whether the economy is being driven by supply shocks or demand shocks.
When inflation and growth move in opposite directions, a supply-shock world, an inflation scare means higher yields and a weaker growth outlook at the same time: “stagflation”. Bonds fall, stocks fall, and the Fed is tightening into the weakness. Bonds behave like a bet on inflation, and they move with stocks. That described the 1970s and early 80s.
It also described the 1990s, because the market’s operative fear was overheating and Fed tightening, not recession. In 1994, Greenspan doubled the funds rate from 3% to 6% and the bond market was crushed while stocks went nowhere. Good news on growth was bad news for bonds. The same force moved both markets.
When inflation and growth move together, a demand-shock world, a recession brings disinflation and rate cuts. Bonds rally when stocks are falling. They become a hedge against deflation rather than a bet on inflation. That was the world from 2001 to 2021, and it’s what made 60/40 feel safe. The regime break wasn’t lower inflation. It was inflation turning pro-cyclical, once the fear of recession replaced the fear of overheating.
Academic work lines up with what we see in the Chart. John Campbell and his co-authors found that the correlation between inflation and the output gap was negative from roughly 1979 to 2001, then turned positive, and the stock-bond correlation changed sign right alongside it.
2022 showed what the supply-shock world costs. The S&P 500 returned -18.11% on a total-return basis. The Bloomberg US Aggregate, the core bond benchmark, fell 13.01%, its worst year in the history of the index. The safe half of the portfolio cushioned nothing. A 60/40 investor was hit on both sides at once.
The right edge of the chart is what matters for allocation decisions now. The correlation has been positive since 2022. If inflation stays sticky and volatile, a reasonable expectation given fiscal deficits, conflict in the Middle East, and tariff uncertainty, the negative correlation that made 60/40 feel safe may not return for years.
The concern for investors is concrete. Most portfolios still seek to de-risk the way they did in 1995: sell stocks, buy bonds. If bonds and stocks are moving together, that trade buys far less protection than it used to, and it often realizes a tax bill on the way out.
There are other tools that can be added to the equation. For example, one might cushion their portfolio’s downside with equity options, keeping the stock exposure they want while limiting the loss that many investors, particularly those in or nearing retirement, can’t afford. It has a cost. Protection always does. But it holds up even when both halves of the traditional portfolio move together, which is the environment the Chart shows we are in.
The 60/40 still works as a starting point. Its protection depends on a correlation that has now changed its sign, and that is worth considering before the next drawdown, not after.
Sources: S&P Dow Jones Indices (S&P 500 2022 total return -18.11%); Bloomberg US Aggregate Bond Index (2022 total return -13.01%); U.S. Bureau of Labor Statistics CPI data (1990-1998); Campbell, Pflueger & Viceira, “Bond-Stock Comovements,” and Campbell, Sunderam & Viceira, “Inflation Bets or Deflation Hedges?”