For much of the past two decades, investors have been able to rely on a fairly simple relationship. When stocks struggled, bonds often rallied. That relationship did a lot of heavy lifting for the traditional 60/40 portfolio.
However, diversification is often regime-dependent, not constant.
One period that may offer some clues today is the 1990s. The U.S. economy was growing, businesses were spending heavily on new technology, and investors were excited about a major investment cycle. Back then, it was personal computers, telecommunications equipment and the early buildout of the internet. Today, it is artificial intelligence, data centers, semiconductors and the power infrastructure needed to support them.
Both periods have been good for growth, but not necessarily for bonds.
In 1994, the Federal Reserve began raising interest rates in February and the 30-year Treasury yield moved from roughly 6.3% at the start of the year to about 7.9% by year end as markets priced in stronger growth, inflation risk and substantially more tightening.
Essentially, the Fed fired the starting gun, but the bond market did much of the tightening as investors quickly concluded that policymakers were behind the curve. Sound familiar?
Given the parallels to today’s market backdrop, we decided to test what happens to investor portfolios when rising rates are accompanied by a breakdown in the traditional stock-bond diversification relationship.
We looked at nearly 50 years of market history and identified months when two conditions were met at the same time: the 10-year Treasury yield was at least 75 basis points higher than a year earlier, and the trailing 12-month correlation between stocks and bonds was above +0.20. Both conditions are being met today.
There were 92 months that met both conditions and seven periods when both conditions remained in place for at least six consecutive months.
We then tested whether investors could improve on a traditional 60/40 portfolio by replacing a portion of the 40% Treasury allocation with hard assets while the equity allocation remained fixed at 60%. We compared the traditional 60/40 portfolio with a 60/35/5 portfolio, which allocated 5% to an equal-weight basket of gold, silver and copper, and a 60/30/10 portfolio, which allocated 10% to the same basket.
The results were striking.
Figure 1. Portfolio Returns When Yields Rise and Correlations Turn Positive
Sources: Bloomberg L.P. and Potomac. Data from January 1977 through August 2026. Note: Sustained regimes are periods of at least six consecutive months in which the 10-year Treasury yield was at least 75 basis points above its year-ago level and the trailing 12-month stock-bond correlation exceeded +0.20. The 60/35/5 and 60/30/10 portfolios maintain a 60% equity allocation (S&P 500) while replacing 5% and 10%, respectively, of the Treasury allocation with an equal-weight basket of gold, silver and copper. Returns are cumulative over each episode. The average is a simple average of episode returns and is not annualized or weighted by episode length. Treasury returns are modeled from daily 10-year Treasury yields. Hard assets use spot-market proxies and do not include futures roll yield or implementation costs.
Before we dive into the results, we should probably point out that there are really two different eras represented in the table. The first four episodes occurred during the Great Inflation and its immediate aftermath. The first three overlapped with the second oil shock and the broader inflation crisis surrounding the Iranian Revolution, which helps explain some of the enormous hard-asset returns.
For that reason, it is useful to look separately at the sustained regimes beginning in 1994. These three periods occurred in a more modern monetary-policy environment, after the Great Inflation and the Volcker disinflation had largely reset inflation expectations.
The return improvement was more modest, but consistent. Across the 1994-95, 1999-2000 and 2022-23 episodes, the traditional 60/40 portfolio generated a median cumulative episode return of just 2.1%. Replacing 5% of the Treasury allocation with hard assets increased that to 2.6%, while a 10% allocation increased it to 3.1%.
The more interesting result, however, was what happened to the diversification ratio. For those unfamiliar, the diversification ratio compares the volatility of the portfolio’s individual components with the volatility of the combined portfolio. A higher ratio means the assets are creating more diversification.
Figure 2. Portfolio Return and Diversification During Post-1994 Sustained Regimes
Sources: Bloomberg L.P. and Potomac. Data from April 1994 through March 2023. Note: Post-1994 includes the three sustained regimes beginning in 1994, 1999 and 2022. All figures represent median outcomes across the three sustained post-1994 regimes. Diversification Ratio measures how much diversification the combined portfolio receives relative to the weighted volatility of its individual components; higher is better. Diversification Benefit expresses the corresponding reduction in portfolio volatility as a percentage.
As figure 2 highlights, the hard-asset sleeve did more than modestly improve returns. It also improved the structure of the portfolio. The diversification ratio increased in all three post-1994 episodes for both the 5% and 10% allocations. Across all seven historical episodes, the diversification ratio also improved every single time.
The reason is not all that surprising. During the post-1994 regimes, hard assets had a median correlation of only about +0.03 with stocks and -0.13 with Treasuries. When stocks and bonds were behaving more alike, hard assets introduced a genuinely different return stream.
If we look at 1994, which has some similar characteristics to today’s economic backdrop, stocks and Treasuries had a daily correlation of about +0.62. Hard assets, on the other hand, had a -0.23 correlation with stocks and a -0.29 correlation with Treasuries.
Positive stock-bond correlation alone is not necessarily a problem because stocks and bonds can move together while both are generating positive returns. However, the problem tends to occur when positive correlation is paired with a meaningful rise in interest rates. In that environment, the bond allocation can lose the defensive characteristics investors expect from it.
That brings us back to today. Even though our criteria for the study have been met, it does not guarantee that another sustained episode is beginning. But the historical setup is definitely worth paying attention to and the historical evidence suggests modest allocations to hard assets may help investors to diversify during times of rising interest-rate uncertainty.
Not because they always produce spectacular returns, but because they can introduce a genuinely different return stream at exactly the point when stocks and bonds are behaving more alike.
Remember: diversification is often regime-dependent, not constant. And sometimes when diversification gets harder, it may make sense to look at hard assets.
