By Aoifinn Devitt, CFP® – Chief Investment Officer
Many of our clients have read this recent article in the Wall Street Journal and have asked us to respond. It cites the banner performance of the traditional 60/40 balanced portfolio (60% stock /40% bond allocation) over the past 40 years but suggests that its halcyon days are behind it. The article further suggests that this asset mix is not only challenged going forward but essentially dead in the water, claiming that “the formula of building a nest egg by rebalancing a standard mix of stocks and bonds isn’t going to work nearly as well as it has.”
The basic thesis of this argument is that stocks are expensive and long-term Treasury yields are at their highest levels in 16 years, after a recent stark sell-off.
Let’s break this down piece by piece.
Firstly, it is true that the traditional 60/40 balanced portfolio enjoyed a long run of success. Decades of easy monetary policy led to a bond “bull run” and equity markets enjoyed solid annual returns fueled by the same policy, among other factors. It is also true that in 2022 this portfolio was caught in a double bind and showed deep negative performance. The unprecedented pace of rate rises by the US Federal Reserve as well as broad-based equity market corrections led to one of the ugliest market environments in decades. The balanced portfolio had nowhere to hide – and it showed.
Now let’s analyze the outlook for stocks and bonds today, the outlook for a pure 60/40 portfolio and why looking at the “pure” portfolio may in fact be misguided.
Starting with stocks, we question whether stocks today are in fact “expensive”. While 2023 has seen a soaring market for tech stocks – particularly the “Magnificent Seven” (Microsoft, Alphabet, Amazon, Apple, Tesla, NVIDIA, and Meta), certain sectors have flailed and currently languish close to levels seen at the beginning of the year.
Overall US stock market valuation metrics also don’t point to extreme overvaluation and when we look to global markets the valuation picture looks more balanced.
It is true that this resilience in equity markets has been a bit of a surprise. It has broadly silenced those market commentators who predicted a recession in 2023 and the consumer stress expected to follow rising rates has not (yet) materialized. Instead, the robust employment picture and residual overhang of pandemic savings have boosted the consumer, and, following a few quarters of cautionary outlooks, the current corporate earnings season is expected to be buoyant. There are technical factors, too, that suggest equities will remain supported – there are still record levels of assets in money market funds, which recently topped $5 trillion in the US.
Moving to bonds, the expansion in bond yields caused by the sell-off in bonds actually makes bonds (and cash) an attractive standalone holding for the first time in years. Yields of close to 5% in cash mean that cash is no longer a drag on portfolios and as inflation ticks downwards this represents a healthy net of inflation yield. Usually a sell-off represents an attractive “entry point” instead of an “off ramp” for assets. While interest rates may well remain “higher for longer” it is widely expected that the incremental upside on rates will be nothing like the steepness of the trajectory that 11 rate rises in the past 18 months have represented. In short, while we expect more volatility in bonds going forward, we don’t see a lot of downside at current bond valuations – particularly if investors can buy and hold.
It is important to say that at Moneta our attitude has never been “set it and forget it” when it comes to balanced portfolios – or any portfolios. Over recent years we have been modifying the traditional 60/40 stock/bond mix by introducing suitable additional diversifiers into the portfolio – these include real assets such as real estate, infrastructure, and real assets, designed to add yield, inflation resilience and an uncorrelated source of return.
We have added private credit holdings as an extension of our bond holdings – this exposure to non-bank lenders offers diversification away from the potential contagion of trouble in the banking sector (as was briefly seen among the US regional banks just this Spring). Even the traditional asset classes of bonds and equities are subject to frequent re-underwriting and assessment based on their suitability as market conditions change. We have always believed that the best offense is a good defense and portfolios have been designed with volatility – and not the latest shiny object – in mind. It is here we should note that we have never recommended digital assets or cryptocurrencies within portfolios.
Turning to risks on the horizon, the article cites the potential for home prices to crash and for persistent inflation to undermine portfolio returns. It also refers to the US government’s financing woes and how this could be the “wild card” to jeopardize the bond market. These are real risks, but the reality is somewhat nuanced and more complex than a sensationalist headline would suggest.
Home prices could weaken – but we are nowhere close to the excesses in terms of lending seen prior to the 2008 financial crisis and volumes are already down to those levels as mortgage interest rates hover at 22 year highs. Inflation is in retreat if not fully back to policymaker targets, while the bond market is subject to complex demand/supply dynamics and the US government’s need to issue more debt is only one aspect to this.
Interestingly, at its conclusion the article recommends doing what we have always done here at Moneta: our equity portfolios are broadly diversified by cap size, sector and growth – and are not “pure” S&P exposure. Our bond portfolios don’t huddle in shorter dated bonds though, because over time we believe in the importance of maintaining exposure across the curve.
The Moneta investment team are well aware of the stresses of the current environment and the nagging effect of uncertainty and being in uncharted territory when it comes to inflation, rates and the ascent of tech. We are also wary of the bias to action – to “not just stand there” but to “do something” in response. However at times like this, we return back to our roots, to our Investment Beliefs and our focus on portfolio construction that is resilient to market forces and throughout cycles. We continue to believe that “patient savers able to grit their teeth through bubbles, crashes and geopolitical upheaval” will win the money game.
We don’t believe that we are in the best of times – there is a wall of worry on the horizon and all investment involves risk. But equally we don’t believe we are in the worst of times. Recently the world has sometimes seemed to be “upside down” – good news (economic resilience) has seemed to be bad for markets and “bad news” (rising unemployment) has been received as good. But every time we come back to balance. This is not the time to jettison the balanced portfolio. But it is the time to ensure it is an optimally diversified one.
DISCLOSURES
© 2023 Advisory services offered by Moneta Group Investment Advisors, LLC, (“MGIA”) an investment adviser registered with the Securities and Exchange Commission (“SEC”). MGIA is a wholly owned subsidiary of Moneta Group, LLC. Registration as an investment adviser does not imply a certain level of skill or training. The information contained herein is for informational purposes only, is not intended to be comprehensive or exclusive, and is based on materials deemed reliable, but the accuracy of which has not been verified.
Trademarks and copyrights of materials referenced herein are the property of their respective owners. Index returns reflect total return, assuming reinvestment of dividends and interest. The returns do not reflect the effect of taxes and/or fees that an investor would incur. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information contained herein is subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax or legal decision. An index is an unmanaged portfolio of specified securities and does not reflect any initial or ongoing expenses nor can it be invested in directly. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.
DEFINITIONS
Asset class valuations are a percentile ranking based on monthly data going back to common inception of 9/1/2006. The US Large Cap percentile is the average percentile ranking of the trailing P/E, P/B, P/S, and P/C ratio of the S&P 500 Index. The US Small Cap percentile is the average percentile ranking of the trailing P/E, P/B, P/S, and P/C ratio of the Russell 2000 Index. The International Developed percentile is the average percentile ranking of the trailing P/E, P/B, P/S, and P/C ratio of the MSCI EAFE NR Index. The Emerging Market percentile is the average percentile ranking of the trailing P/E, P/B, P/S, and P/C ratio of the MSCI Emerging Markets NR Index. The 10-Year US Treasury percentile is the percentile ranking of the 10-Year US Treasury yield. The Investment Grade percentile is the percentile ranking of the ICE BofA US Corporate option adjusted spread. The High Yield Corporate percentile is the percentile ranking of the ICE BofA US High Yield corporate option adjusted spread. The Municipal/Treasury percentile is the percentile ranking of the Bloomberg Municipal Index yield divided by the 10-Year US Treasury Yield.
