Asset Allocation Insights
A Challenging Environment for Stocks and Bonds
Tim Murray, CFA Capital Markets Strategist, Multi‑Asset Division
Key Insights
  • Global stocks and bonds have both declined year‑to‑date, frustrating investors who typically rely on the diversifying benefits of fixed income allocations.
  • We believe that expectations for interest rate hikes have largely been priced in; therefore, the positive correlation between stock and bond performance is, in our view, unlikely to be sustained.

During the first part of 2022, stocks declined sharply due to rising geopolitical uncertainty and accelerated inflation. Notably, bonds—which typically help to manage downside risk in a portfolio—pulled back almost as much as stocks (Fig. 1), frustrating investors who often rely on the diversifying benefits of fixed income securities during equity market sell‑offs. 

While stock and bond returns historically tend to have low or negative correlations over the long term, correlations have at times been positive over shorter periods. Environments where expectations for central bank tightening are increasing rapidly, in particular, can be challenging for both asset classes (Fig. 2). This is because rising interest rates typically push yields higher and bond prices lower. Meanwhile, stocks usually suffer in a rising rate environment because rate hikes often slow down economic growth, resulting in lower earnings. 

Rate hike expectations have increased rapidly in early 2022. At the beginning of the year, markets generally expected the U.S. Federal Reserve to raise rates at a measured pace—despite already elevated inflation—and then pause with rates still at relatively low levels. However, this outlook shifted dramatically in the first quarter, as inflation concerns were exacerbated by Russia’s invasion of Ukraine and a spike in oil prices.

Although a cautious approach is warranted amid growing economic headwinds, we believe that expectations for more hawkish central bank policies have largely been priced into asset valuations. If this view is correct, the strong positive correlation between stock and bond returns seen in early 2022 is unlikely to be sustained. As a result, the Asset Allocation Committee has further increased its allocation to long duration1 U.S. Treasuries, which the committee believes are more likely to offer portfolio diversification2 potential now that yields have adjusted higher.

A Difficult Year So Far for Stocks and Bonds

(Fig. 1) Both asset classes have declined meaningfully year‑to‑date

Both asset classes have declined meaningfully year‑to‑date

Past performance is not a reliable indicator of future performance.

December 31, 2021, to April 26, 2022

Sources: Standard & Poor’s and MSCI (see Additional Disclosures). Bloomberg Finance L.P. T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved.

Rate Hikes Have Presented Headwinds for Both Stocks and Bonds

(Fig. 2) Correlations were higher when rate hike expectations were rising*

Correlations were higher when rate hike expectations were rising*

Past performance is not a reliable indicator of future performance.

January 2006 to March 2022

Source: Bloomberg Finance L.P.

*Fed rate hike expectations calculated as the difference between the 2‑year U.S. Treasury yield and the federal funds rate. Stock and bond correlation is the rolling 2‑year correlation of monthly price changes for the S&P 500 Index and U.S. 10‑Year Treasury futures. Correlation measures how one asset class, style or individual group may be related to another. A perfect positive correlation means that the correlation coefficient is exactly 1. This implies that as one security moves, either up or down, the other security moves in lockstep, in the same direction. A perfect negative correlation (‑1) means that two assets move in opposite directions, while a zero correlation implies no relationship at all.

1 Duration measures a bond or other debt instrument’s price sensitivity to a change in interest rates.

2 Diversification cannot assure a profit or protect against loss in a declining market.

Additional Disclosures

Copyright © 2022, S&P Global Market Intelligence (and its affiliates, as applicable). Reproduction of any information, data or material, including ratings (“Content”) in any form is prohibited except with the prior written permission of the relevant party. Such party, its affiliates and suppliers (“Content Providers”) do not guarantee the accuracy, adequacy, completeness, timeliness or availability of any Content and are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, or for the results obtained from the use of such Content. In no event shall Content Providers be liable for any damages, costs, expenses, legal fees, or losses (including lost income or lost profit and opportunity costs) in connection with any use of the Content. A reference to a particular investment or security, a rating or any observation concerning an investment that is part of the Content is not a recommendation to buy, sell or hold such investment or security, does not address the suitability of an investment or security and should not be relied on as investment advice. Credit ratings are statements of opinions and are not statements of fact.

MSCI and its affiliates and third‑party sources and providers (collectively, “MSCI”) makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI. Historical MSCI data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of May 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. Actual outcomes may differ materially from expectations.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Fixed‑income securities are subject to credit risk, liquidity risk, call risk, and interest‑rate risk. As interest rates rise, bond prices generally fall. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc.

© 2022 T. Rowe Price. All Rights Reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the Bighorn Sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc.

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