Irregular Correlations

Irregular Correlations

July 29, 2022

2022 has, thus far, been one of the most unique periods in the history of financial markets. The combination of high inflation and aggressive tightening of monetary policy from the Federal Reserve (the USA’s central bank) have created an environment where safe havens are in short supply.

When stock prices are declining, investors often shift to Treasuries in an attempt to protect their capital.  Stocks and bonds have tended to move in opposite directions, which is why they can provide a potential downside cushion for portfolios. However, that inverse correlation has not, thus far, been present in 2022.

Through mid-June, stock prices had been on the decline, most likely due to slowing growth in the U.S. economy, inflationary pressures on corporate earnings, and weakening consumer sentiment.  At the same time, bond prices were also falling as investors priced in a rapid series of expected rate increases from the Fed.  The central bank tightening conditions at the same time that economic growth is slowing is reminiscent of some of the worst periods for performance in the capital markets.

Stocks and bonds falling together over an extended period is rare, however.  The degree to which both asset classes have fallen from their peaks this year is virtually without comparison.

The chart below shows the performance of the S&P 500 during its 20 largest drawdowns since 1961 along with the corresponding performance of long-term Treasuries and Utilities.


Source: Bloomberg

During periods where both asset classes decline, Treasuries rarely lose even half as much as the S&P 500.  This could reasonably be expected to be the case since bonds are traditionally less volatile than stocks and drawdown risk is expected to be lower.

There have been cases where stocks and Treasuries have both fallen during 10%+ market corrections, but one would have to go back to 1999 to find the most recent one. Perhaps the closest comparisons to today’s market occurred during 1968-1970 and 1987. In each instance, Treasuries fell by at least 10%, while the S&P 500 declined by more than 30%.

The former event helped to usher in the “stagflation ‘70s”, while the latter was the Black Monday crash.  Both are unusual market outliers.

The main observation is that never in the past 60 years have we seen an instance where both the S&P 500 and long-term Treasuries have declined by at least 20% at the same time. 2022 is the first such case.

The steep decline in both assets means that traditional risk-on/risk-off strategies haven’t worked this year. As long as that inverse relationship between stocks and bonds keeps failing to materialize, these strategies are unlikely to minimize drawdown risk and investors will be the ones to suffer.

This year has been the rare instance where risk-on/risk-off hasn’t worked.  Rotations don’t matter when everything in your opportunity set correlates.  There will be a time when conditions normalize and traditional intermarket relationship begin working again, and if there’s any positive to the current environment, it’s that now there’s room to make money in Treasuries when traditional risk-on, risk-off dynamics returns.

Note: we may be seeing that beginning stages of a reversion to that correlation mean, as the 10-year Treasury yield failed to crest above 3.5% on June 14th and has been mostly heading south since.  Stay tuned…


This material is provided as a courtesy and for educational purposes only.  Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.  Indexes are unmanaged and do not incur management fees, costs, or expenses.  It is not possible to invest directly in an index.

A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). A bond could be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments. Bonds are used by companies, municipalities, states, and sovereign governments to finance projects and operations. Owners of bonds are debtholders, or creditors, of the issuer.