A simple rule of thumb holds that you should devote 60% of your portfolio to stocks and 40% to bonds. (Not everyone agrees with that, but it has been an idea that has been popular).
But that obviously didn’t work too well last year, when the S&P 500 returned a negative 18.11%, and the Bloomberg U.S. Aggregate Total Return bond index lost 13%. Soaring interest rates and inflation had stocks and bonds reeling.
So is the 60-40 portfolio dead? No, says Vanguard and many others.
“Although it is impossible to say with confidence when equity and bond markets will bottom, valuations and yields are clearly more attractive than they were a year ago,” Roger Aliaga-Diaz, head of portfolio construction at Vanguard, wrote in a commentary.
Economic weakness and falling inflation will likely push the Fed to stop raising interest rates around mid-year, experts say. And bonds could rally after that.
Annual inflation has slid from a 40-year high of 9.1% in June to 7.1% in November.
Vanguard’s Rosier Outlook for Stocks, Bonds
While economic weakness isn’t good for stocks, falling interest rates are. And when the economy does rebound, stocks are likely to benefit.
For stocks and bonds to continue moving down at the same time, “it would take long periods of consistently high inflation,” Aliaga-Diaz said.
“Our outlook for global stocks and bonds has reversed its downward trend in the last decade,” he said.
“This higher return outlook is in large part because of higher interest rates to fight inflation, which caused asset price declines through the equity valuation and bond yield channels.”
Looking forward, “these forces also raised expectations for the next decade, because yields on developed-market sovereign [government] debt are the foundation on which other risky returns are built.”
Presumably, yields will decline once the Fed quells inflation.
BlackRock Skeptical of 60-40 Portfolio
Michael Gates, head of model portfolio solutions for BlackRock's multi-asset strategies group, sees things a bit differently.
“In the wake of the covid-19 pandemic, a new regime of lower returns, higher volatility, and resurgent inflation appears afoot,” he wrote in a September commentary.
“Such a challenging environment is prone to disrupt the once dependable success of the classic 60% stock/40% bond portfolio and the broader efficacy of fixed income as a source of meaningful diversification.”
He may well be right. But take Gates’ view with a grain of salt. BlackRock benefits when its customers buy alternative investments, as those fees are generally higher than those for plain-vanilla stocks and bonds. To be sure, that doesn’t mean the firm’s view is biased, but that’s a possibility.
Some experts recommend staying away from alternatives, as they’re expensive and the diversification, risk, and return benefits are questionable.
In any case, as you might guess from what Gates wrote above, he recommends selling bonds to raise cash for buying alternative investments.
That’s because “in the current market environment, historically low but rising rates and elevated inflation can create a hostile environment for fixed income,” he wrote.
So how should investors choose alternative investments if they decide to take the plunge?
“Since we are funding our alternatives allocation from bonds, we aim to find alternative strategies that have historically exhibited defensive characteristics similar to bond funds,” Gates said.
