Does the Hedge Hold? A Study of Stock–Bond Correlation
Macroeconomic Perspectives, Q4 2025 • Anika Harode
Introduction
For decades, the 60/40 portfolio has been shorthand for balance: 60% equities for growth, 40% bonds for stability. The logic seemed simple and durable: when growth faltered and stocks fell, Treasurys tended to rally, and the fixed income sleeve absorbed the shock.
| Year | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 |
|---|---|---|---|---|---|---|---|---|---|---|---|
| Stocks & Bonds Correlation * | -0.18 | -0.24 | -0.37 | -0.15 | -0.49 | 0.43 | 0.30 | 0.54 | 0.63 | 0.13 | 0.01 |
| YoY Change in Core CPI (%) | 0.12 | 1.27 | 2.13 | 2.44 | 1.81 | 1.26 | 4.68 | 7.99 | 4.12 | 2.95 | 2.15 |
| *correlation between yearly percent change in stock and bond index prices | |||||||||||
But relationships that feel timeless in markets often prove to be regime dependent. Table 1 tells the story. From 2015 through 2020, stock1–bond2 correlations stayed negative, troughing at –0.63 in 2019, while core CPI3 remained contained at 0.12% to 2.44%. Bonds reliably offset equity volatility in this environment. But the pandemic shock and inflation surge unraveled this logic. Correlations flipped positive (0.25 in 2021, rising to 0.66 in 2023) as core CPI surged to 7.99%. In these years, discount rate shocks drove both stocks and bonds down together, undermining diversification precisely when it was most needed.
Even as inflation has cooled back to 2.15% in 2025, correlations have drifted toward zero, and the hedge properties of Treasurys appear diminished, not restored. The central question now is whether investors can still lean on the classic 60/40, or if the portfolio’s safety net has frayed beyond repair.
Can the 60/40 Still Protect You?
The weakening of the Treasury hedge has also been documented in broader research. The Bank for International Settlements (BIS)4 notes that equity–bond correlations turned persistently positive in mid-2021, a regime not seen since the 1980s. They attribute this shift to inflation shocks overwhelming growth signals, leaving bonds to fall alongside equities rather than offsetting them.
To test whether bonds still provide a sizable hedge, we look directly at episodes of equity drawdown. Drawdown periods are defined as when stocks breach a minimum 10% drawdown. The start date of this period is a local peak, and the end date is defined as the day of maximum drawdown from the respective peak. From each peak to trough, we start by tracking stock returns, bond returns, and the performance of a 60/40 blend. We also compute a portfolio beta: how much the portfolio moves for every 1% decline in equities. This standardizes the episodes and makes them easier to compare across regimes and variations in portfolio structures.
| Drawdown Period | Stocks Return % | Bonds Return % | Bond Sensitivity to 1% Decrease in Stocks % | Portfolio Return % | Portfolio Beta | YoY Core CPI |
|---|---|---|---|---|---|---|
| 09-Oct-2007 — 09-Mar-2009 | -56.78 | 25.07 | 0.44 | -24.04 | -0.42 | -0.32 |
| 21-May-2015 — 11-Feb-2016 | -14.16 | 13.25 | 0.94 | -3.20 | -0.23 | 1.27 |
| 26-Jan-2018 — 08-Feb-2018 | -10.16 | -3.76 | -0.37 | -7.60 | -0.75 | 2.44 |
| 20-Sept-2018 — 24-Dec-2018 | -19.78 | 4.53 | 0.23 | -10.05 | -0.51 | 2.44 |
| 19-Feb-2020 — 23-Mar-2020 | -33.93 | 14.23 | 0.42 | -14.66 | -0.43 | 1.25 |
| 03-Jan-2022 — 12-Oct-2022 | -25.43 | -29.33 | -1.15 | -26.99 | -1.06 | 7.99 |
| 19-Feb-2025 — 08-Apr-2025 | -18.90 | 0.84 | 0.04 | -11.01 | -0.58 | 2.26 |
The evidence in Table 2 shows how the classic 60/40 portfolio’s hedge properties have shifted. In the 2007–09 crisis, stocks collapsed by –56.8%, yet bonds rallied +25.1%, limiting the portfolio’s decline to –24%. The portfolio beta, –0.4, implied that more than half of the equity drawdown was absorbed by the bond sleeve. Even in smaller mid-cycle corrections, like mid-2018, bonds still helped: stocks fell –19.8%, bonds rose +4.5%, and the 60/40 lost –10.1%, with a portfolio beta of –0.5.
But in the inflationary regime, this protection broke down. In 2022, when equities fell –25.4%, bonds fell too (–29.3%), dragging the 60/40 portfolio down –27.0%. The beta spiked to –1.1, showing bonds amplified, rather than offset, the decline. Even the more recent 2025 drawdown highlights diminished ballast: equities dropped –18.9%, bonds saw only a small gain (+0.8%), and the portfolio still fell –11.0% with a portfolio beta of –0.6. This –0.6 beta in 2025 compared to the –0.4 beta in 2007–09 demonstrates how bonds have weakened as a hedge over time.
Taken together, these episodes illustrate a shift. In disinflationary environments, bonds consistently absorbed shocks and stabilized portfolios. In inflationary environments, the hedge properties of Treasurys were weakened or reversed, leaving the 60/40 exposed at the very moments it was designed to protect.
Searching for Better Shields
If the 60/40’s safety net has frayed, the natural next step is to ask whether diversification can restore it. Are there assets that cushion equity stress when bonds fail, or are Treasurys still the only reliable counterweight — just less effective in an inflationary regime? To test this, we run the same stress-event framework on two alternative allocations:
Alternative Portfolio I: 60% stocks, 15% bonds, 15% cash, 10% gold.
Alternative Portfolio II: 60% stocks, 15% bonds, 15% cash, 10% hedge funds.
The goal is not to replace bonds entirely, but to see whether layering in other diversifiers meaningfully improves downside protection.
| Drawdown Period | Portfolio Return % | Portfolio Beta | YoY Core CPI |
|---|---|---|---|
| 09-Oct-2007 — 09-Mar-2009 | -27.55 | -0.49 | -0.32 |
| 21-May-2015 — 11-Feb-2016 | -6.13 | -0.43 | 1.27 |
| 26-Jan-2018 — 08-Feb-2018 | -6.91 | -0.68 | 2.44 |
| 20-Sept-2018 — 24-Dec-2018 | -10.62 | -0.54 | 2.44 |
| 19-Feb-2020 — 23-Mar-2020 | -18.46 | -0.54 | 1.25 |
| 03-Jan-2022 — 12-Oct-2022 | -20.28 | -0.80 | 7.99 |
| 19-Feb-2025 — 08-Apr-2025 | -10.99 | -0.58 | 2.26 |
Table 3 shows how gold5 and cash6 can reshape outcomes. During times of low inflation — such as 2007-2009, 2015-2016, and 2020 — the classic 60/40 portfolio produced better overall returns, as bonds still provided meaningful protection. However, in periods of elevated inflation, such as 2022, the alternative portfolio outperformed by cutting losses significantly. Although returns on Gold’s investment were negative during this period, their impact on the overall portfolio reduced total losses from -27.0% in the 60/40 to -20.3%, a notable improvement in a regime where Treasurys failed as a hedge.
| Drawdown Period | Portfolio Return % | Portfolio Beta | YoY Core CPI |
|---|---|---|---|
| 09-Oct-2007 — 09-Mar-2009 | -30.49 | -0.54 | -0.32 |
| 21-May-2015 — 11-Feb-2016 | -6.64 | -0.47 | 1.27 |
| 26-Jan-2018 — 08-Feb-2018 | -6.66 | -0.66 | 2.44 |
| 20-Sept-2018 — 24-Dec-2018 | -11.25 | -0.57 | 2.44 |
| 19-Feb-2020 — 23-Mar-2020 | -18.38 | -0.54 | 1.25 |
| 03-Jan-2022 — 12-Oct-2022 | -19.79 | -0.78 | 7.99 |
| 19-Feb-2025 — 08-Apr-2025 | -11.19 | -0.59 | 2.26 |
The hedge fund7 allocation in Table 4 highlights how this second alternative fits into the picture. In low inflation regimes such as 2007–09 and 2015-2016, bonds rallied strongly while hedge funds offered limited or even negative offsets. But in high inflation periods such as 2022, hedge funds proved more resilient. During this period, when both stocks and bonds fell sharply, hedge funds returned –2.2%, allowing the portfolio to decline to only –19.8%, with an alternative II portfolio beta slightly lower than –0.8. Though this beta may not initially appear significant, it is the highest across all three portfolios in this episode, indicating that hedge funds provided meaningful downside relief at a time when traditional fixed income failed.
Together, these experiments suggest that diversification can help — but not all diversifiers are equal. What remains clear is that bonds are no longer the singular, reliable hedge they once were.
Inflation Regimes and Hedge Effectiveness
The final step is to compare these portfolio outcomes within the inflation regimes. Doing so makes clear that it is not just the size of drawdowns that matters, but the economic backdrop shaping whether bonds, gold, or hedge funds provide the stronger hedge. Table 5 illustrates this relationship by comparing portfolio betas across drawdowns alongside year-over-year changes in Core CPI.
| Drawdown Period | Classic Portfolio Beta | Alternative Portfolio I Beta | Alternative Portfolio II Beta | YoY Core CPI |
|---|---|---|---|---|
| 09-Oct-2007 — 09-Mar-2009 | -0.42 | -0.49 | -0.54 | -0.32 |
| 21-May-2015 — 11-Feb-2016 | -0.23 | -0.43 | -0.47 | 1.27 |
| 26-Jan-2018 — 08-Feb-2018 | -0.75 | -0.68 | -0.66 | 2.44 |
| 20-Sept-2018 — 24-Dec-2018 | -0.51 | -0.54 | -0.57 | 2.44 |
| 19-Feb-2020 — 23-Mar-2020 | -0.43 | -0.54 | -0.54 | 1.25 |
| 03-Jan-2022 — 12-Oct-2022 | -1.06 | -0.80 | -0.78 | 7.99 |
| 19-Feb-2025 — 08-Apr-2025 | -0.58 | -0.58 | -0.59 | 2.26 |
In low-inflation environments — such as 2007–09, 2015–16, and 2020 — the classic 60/40 portfolio remained a strong hedge. In the 2007–09 crisis, for instance, the 60/40 portfolio beta of –0.42 meant that the portfolio lost less than half as much as equities. Portfolios with alternative investments (–0.49 to –0.54 betas) offered only marginal improvements, since Treasurys were already cushioning losses effectively. A similar pattern held in 2015–16 and 2020, when all portfolio betas clustered between –0.23 and –0.54, consistent with bonds working well in a muted inflation backdrop (CPI ≤1.3%).
The story changes in high-inflation regimes. The contrast was sharpest in 2022, when year-over-year CPI surged to 7.99%. The 60/40 portfolio beta collapsed to –1.06, showing that bonds amplified equity losses rather than offsetting them. By comparison, the gold/cash and hedge fund allocations held up significantly better, with betas of –0.78 to –0.80, absorbing more of the shock when it mattered most.
By 2025, with CPI easing to 2.26%, portfolios once again converged near –0.58 to –0.59. This suggests that while Treasurys no longer actively amplified drawdowns, they also have not returned to their historical role as dependable hedges. Alternatives added little incremental benefit in this lower inflation regime, but their importance remains clear in environments where inflation risk dominates.
In short, the portfolio beta analysis confirms that bonds hedge effectively when inflation is low and stable, but alternatives become essential when inflation is high and volatile. The higher (less negative) the beta, the more protection investors retain — and in recent years, only diversified portfolios provided that cushion.
This relationship has shown effect well before the 2000s as well. Between 1970 and 1980, U.S. equities and Treasuries displayed a mildly positive correlation of +0.17 on an annual return basis. This pattern reflects the inflationary backdrop of the decade, when both asset classes were pressured by macroeconomic shocks. Equity markets suffered sharp drawdowns in 1973–74 and again in 1977, while bondholders saw persistent erosion in real returns as inflation accelerated. The limited diversification benefit is evident: in contrast to the negative correlations that emerged in the 1990s and 2000s, the 1970s environment often left investors with few safe harbors. Rather than providing an offset in downturns, bonds frequently moved in the same direction as stocks, underscoring the challenges of portfolio construction during a stagflationary regime.
A New Playbook for Protection
The lesson from these episodes is not that diversification has lost its value, but that the nature of the hedge must evolve with the regime. In a world of rising inflation, simply relying on Treasurys is no longer enough. Gold and cash can soften the blow, but they are blunt tools. What matters is constructing hedges that work not only against equity volatility, but also against the macroeconomic forces — inflation shocks, policy shifts, rising discount rates — that drive assets to fall together.
At Fourth Wall, we build portfolios with this reality in mind. We view hedges not just as insurance against market drawdowns, but as protection during the moments when it matters most: when inflation erodes purchasing power and consumers need stability the most. Hedge fund strategies, with their ability to take both long and short positions across asset classes, offer a more flexible response to inflationary stress than static allocations. They are not about replacing bonds, but about adding tools that adapt when regimes shift.
The core of our approach is simple: protection should not vanish in the exact moments it is needed most. By positioning portfolios to withstand high-inflation regimes, we equip our clients to preserve capital and stay invested, rather than being forced into reactive decisions when markets and households alike are under strain. In today’s environment, that’s not just prudent, it’s essential.
Appendix
Methodology Index
To ensure clarity and reproducibility, the analysis rests on a few key design choices:
Equity Sleeve: The S&P 500 Index is used to represent equities. It captures broad U.S. market performance and is the most common benchmark for systemic equity risk.
Bond Sleeve: Bonds are proxied by VBTLX (Vanguard Total Bond Market Index Fund). With an effective duration of roughly 6 years, it reflects the exposure many investors hold in the “40” allocation — Treasurys, mortgages, and investment-grade corporates.
Alternative Assets:
Gold is included as a real asset hedge, historically resilient during inflationary shocks.Cash is treated as a zero-return stabilizer, offering ballast when other assets fall.
Cash is treated as a zero-return stabilizer, offering ballast when other assets fall.
Hedge funds are proxied through a broad index of diversified strategies, used to approximate unconstrained, long/short exposures.
Drawdown Identification: Stress events are defined as the first day the S&P 500 falls 10% from its prior peak. This ensures we capture meaningful episodes of equity stress, rather than short-term volatility.
Portfolio Construction: Returns are calculated as weighted blends (e.g., 60/40, 60/15/15/10). In addition to reporting raw returns, we calculate portfolio beta: the ratio of portfolio loss to stock loss during each event. A beta of –0.55, for example, means the portfolio falls 0.55% for every 1% decline in equities. This standardizes the drawdowns and makes it easier to compare hedge effectiveness across different regimes.
These choices balance transparency and practicality: using widely recognized benchmarks, applying simple but robust definitions of stress, and focusing on allocations that investors actually hold.
Related Literature
Our findings align with research from the Bank for International Settlements (BIS, Dec 2023). Lombardi and Sushko document that the correlation between equity and bond returns turned positive in mid-2021 — a shift not seen since the 1980s. They show that correlation regimes hinge on inflation:
In low, stable inflation, growth shocks dominate, leading to negative correlations.
In high, volatile inflation, inflation shocks dominate, driving both equities and bonds down together.
This dovetails with our results: during disinflationary drawdowns (2007–09, 2015, 2018), bonds provided reliable hedges. In contrast, in 2022 — when core CPI peaked near 8% — bonds fell alongside stocks, amplifying portfolio losses. The BIS also notes that positive correlations raise the required term premium in government bonds, pushing yields higher and weakening their role as hedges even further.
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