Baseball legend Yogi Berra, known as much for his colorful observations as his accomplishments on the field, once remarked, “It’s déjà vu all over again.” Investors who lived through the inflationary 1970s and 1980s may be experiencing a similar sense of familiarity as rising interest rates and inflation concerns challenge the traditional relationship between stocks and bonds. For decades, the 60% stocks and 40% bonds (a 60/40 portfolio) has been a cornerstone of portfolio construction, combining the growth potential of equities with the income and diversification benefits of fixed income. Yet history suggests that the diversification benefits of this approach can vary considerably depending on the economic environment.
While investors have grown accustomed to bonds providing a counterbalance to equity market declines, this relationship has not always held true. As illustrated in the chart below, stocks and bonds exhibited predominantly positive correlations during much of the late 1970s, 1980s and 1990s, before shifting to negative correlations during the following two decades. In the time period shown, the relationship has turned positive again, reflecting an environment in which inflation and interest rates have become increasingly important drivers of both asset classes. When stocks and bonds move in tandem, particularly during market declines, the diversification benefits of a traditional 60/40 portfolio can diminish, leaving investors more exposed to losses than they might otherwise expect.
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Source: Bloomberg for the S&P 500® Index and Bloomberg U.S. Aggregate Index. Data from January 1979 through September 2026. Correlation represents the rolling 36-month correlation of monthly total returns. Past relationships may not persist, and correlation can change over time. |
The relationship between stocks and bonds is influenced by the underlying economic environment. During many periods of slowing economic growth and declining inflation, bonds have historically provided a counterbalance to equities, as falling interest rates may support bond prices even as stocks decline. However, when inflation and rising interest rates become the primary concerns, both asset classes can come under pressure simultaneously. Rising interest rates generally put downward pressure on existing bond prices and can weigh on equity valuations by increasing discount rates and borrowing costs. As a result, the effectiveness of traditional diversification can vary considerably depending on the forces driving financial markets. Higher bond yields can provide higher income and improve prospective return potential, but they do not eliminate the risk of simultaneous declines in stocks and bonds.
While stocks and bonds remain important building blocks of a diversified portfolio, their changing relationship suggests that investors may benefit from additional approaches to managing risk. Hedged equity strategies offer one such approach by combining equity ownership with an options overlay designed to moderate downside exposure while maintaining participation in equity market appreciation. Rather than relying solely on diversification across asset classes, hedged equity seeks to manage risk within the equity allocation itself. Although hedged equity strategies are designed to moderate downside exposure, they may not protect against all market losses, and the cost of hedging and potential limitations on upside participation represent important trade-offs.
Within a traditional 60/40 portfolio, hedged equity may be incorporated as a complement to conventional equity exposure rather than as a replacement for fixed income. By allocating a portion of the equity sleeve to a hedged equity strategy, investors may introduce an additional layer of risk management while maintaining exposure to the long-term growth potential of equities. This approach does not eliminate equity market risk or the possibility of simultaneous declines in stocks and bonds, but it is intended to provide an additional source of risk management within the equity allocation rather than relying exclusively on the diversification benefits of bonds.
Three Approaches to Managing Portfolio Risk
Conclusion
The traditional 60/40 portfolio has endured for good reason, with equities providing long-term growth potential and bonds offering income and diversification. However, history reminds us that the relationship between stocks and bonds is neither constant nor predictable. While traditional diversification remains an important foundation of portfolio construction, incorporating additional approaches to managing equity risk may help investors navigate changing market conditions. Hedged equity offers one potential way to complement traditional diversification while maintaining participation in long-term equity market growth.
IMPORTANT DISCLOSURE INFORMATION:
Please remember that past performance is no guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Connors Investor Services, Inc. [“Connors]), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from Connors. No amount of prior experience or success should be construed as a certain level of results or satisfaction if Connors is engaged, or continues to be engaged, to provide investment advisory services. Connors is neither a law firm nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice.
The market index information and historical correlation data presented are provided for general informational and comparative purposes only. Historical relationships between asset classes may not persist in the future. Indices are unmanaged, do not reflect investment management fees, transaction costs, taxes or other expenses, and are not directly investable. It should not be assumed that your Connors account holdings correspond directly to any comparative indices or categories.
Investments in options involve risks different from, or possibly greater than, the risks associated with investing directly in the underlying securities. The S&P 500® Index is an unmanaged market-capitalization-weighted index generally considered representative of the U.S. large-cap equity market. The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the U.S. investment-grade, taxable fixed-income market. Indices are unmanaged and cannot be invested in directly.
This commentary is not intended for the giving of investment recommendations to any single investor or group of investors, and no investor should rely upon or make any investment decisions based solely on its contents. The indices shown are for informational purposes only and are not reflective of any investment. As it is not possible to invest in the indices, the data shown does not reflect or compare features of an actual investment, such as its objectives, costs and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or return, or tax features. As it is not possible to invest in an index, the information shown does not reflect the features of an actual investment, such as objective, cost and expenses, liquidity, safety, guarantees or insurance, fluctuation of principal or return, or tax features. Hedged equity strategies involve risk, including the possible loss of principal. There can be no assurance that a hedged equity strategy will achieve its investment or risk-management objectives. Hedged equity strategies utilize options and therefore involve risks in addition to those associated with investing directly in equities. Options may expire worthless, hedges may not offset losses in the underlying securities, and option positions may reduce participation in market gains. Hedging involves costs, and there can be no assurance that an options strategy will achieve its intended risk-management objective.