The 2022 Rates Shock and the 60/40 Drawdown

A "60/40" portfolio — 60% equities, 40% bonds — is the default balanced portfolio taught to generations of investors, built on the observation that stocks and bonds usually don't fall together. When growth scares hit stocks, falling rates usually lift bond prices, cushioning the blow. 2022 broke that pattern for an entire calendar year: the S&P 500 fell about 18% and long-term Treasuries fell roughly 30%, at the same time. A standard 60/40 portfolio lost around 16-17%, one of its worst years in a century of data.

What happened

Period, 2022	Equities	Bonds (10y+ Treasuries)	Driver
Jan-Mar	Falling	Falling	Fed signals hikes are coming as inflation runs at 40-year highs
Mar-Jun	Falling sharply	Falling sharply	Fed hikes 0.75pp for the first time since 1994; recession fears build alongside inflation fears
Jul-Aug	Brief rally	Brief rally	Markets hope for a "Fed pivot" that doesn't arrive
Sep-Oct	Falling	Falling further	Fed reiterates "higher for longer"; 10-year yield tops 4%
Full year	-18% (S&P 500)	-31% (long Treasuries)	Both driven by the same variable: expected future interest rates

The mechanism

Stock and bond prices both respond to changes in the interest rate used to discount future cash flows, but they usually don't move together because the reason rates move usually differs by regime. In a growth scare, rates fall because the economy is weakening — bad for stocks, good for bonds. In a growth boom, rates rise because the economy is strong — good for stocks, bad for bonds. Either way, one side of the 60/40 offsets the other.

2022 was neither of those. Inflation, driven by pandemic supply shocks, fiscal stimulus and the war in Ukraine's effect on energy prices, hit its highest level in four decades. The Federal Reserve raised its policy rate from near zero to over 4% in nine months — the fastest tightening cycle since the 1980s — purely to fight inflation, independent of whether growth was strong or weak. A rate move driven by the central bank fighting inflation, rather than by the economy's own strength or weakness, pushes bond prices down directly (higher discount rates mean lower bond prices) and pushes equity valuations down at the same time (higher discount rates mean lower present value of future earnings, and a higher chance the hikes cause a recession). The correlation that made 60/40 diversifying inverted, because the driver of both asset classes was the same variable moving for the same reason.

The lesson

A historical correlation is a description of which shocks have dominated the sample, not a law. Stock-bond correlation had been reliably negative for roughly two decades before 2022, a period dominated by growth shocks (dot-com bust, 2008, COVID) and falling or low inflation — see When Cross-Asset Diversification Fails. That correlation was never guaranteed to hold once the dominant shock changed to inflation, something last seen in the 1970s. A related structural version of this same mechanism, magnified by leverage inside pension funds, produced a much sharper and faster crisis in the UK the same year — see The UK Gilt and LDI Crisis.