Stock and bond divergence offers hope for battered 60/40 portfolio -Breaking
By Davide Barbuscia
NEW YORK (Reuters), – U.S. stock and bond prices are diverging. Investors who seek a combination of these asset classes can find relief from portfolio declines.
Yields on the benchmark 10-year Treasury – which move inversely to prices – are down 28 basis points since May 9, while the has continued a tumble that has brought it to the cusp of bear market territory, often defined as a fall of 20% or more from its highs.
This shift is a change in the way stocks and bonds have performed for 2022. There has been twin falls in fixed income and equities, which has purged investors who use strategies like the 60/40 portfolio as a means to reduce risk.
This strategy relies on stocks rising in economic optimism, and bonds strengthening during times of turmoil. However, this year, expectations for a more hawkish Fed have weighed heavily on both asset types. BlackRock (NYSE: 60/40 Target (NYSE: Allocation fund) The allocation fund follows the standard portfolio strategy of holding 60% in equities, and 40% in fixed-income. This is the worst performance it has seen since its launch in 2006.
“The epicenter of this crisis … is starting to shift from bonds towards other risky assets,” said Pramod Atluri, fixed income portfolio manager at Capital Group.
According to him, investors who have a portfolio of 60/40 will be able to take advantage of the volatility in the equity markets by investing in bonds.
Shifting market worries are the reason investors believe that bonds have reversed. Fears over rising inflation which can devalue future cash flows have reduced the appeal of bonds this year. Expectations of Fed tightening drove yields higher.
Those concerns have more recently been overshadowed by fears that the Fed’s aggressive monetary policy tightening will hurt U.S. growth, with several big Wall Street banks warning of increased chances of a recession ahead. The Fed has already raised rates by 75 basis points and markets are pricing in a total of nearly 300 basis points in increases by March next year – potentially the steepest tightening cycle since 1994.
George Goncalves of MUFG’s U.S. macro strategies said this week that the trend has been from panic in inflation to increasing concern over recession fears.
Performance of the portfolio’s 60/40 split has changed over time. Goldman Sachs Asset Management’s last-year study showed that a portfolio containing a 60/40 combination of U.S. large caps stocks and investment-grade bond yielded an inflation adjusted annual return of 9.1% in 2011-2021. This was far more than the long-term average of 6%.
However, the portfolio’s 60/40 investors would have experienced a loss of money inflation-adjusted, which averaged a negative 0.3% return.
GSAM analysts wrote that elevated valuations and low rates gave investors “many reasons to be concerned that the 60/40 might be dead,” and recommended diversifying into assets such as emerging market equities and international small caps to boost returns.
Joe Davis is Vanguard’s global chief economist, and also heads the investment strategy department. He believes that bonds offer diversification, regardless of the rate of inflation.
He said that once inflation ceases to rise unexpectedly, then the correlation between bonds and stocks drops dramatically, in a positive way. So diversification returns quickly even though inflation remains high.