Sell-everything market sends funds 60/40 in worst case since 2008

The classic 60/40 portfolio — a strategy designated for a share allocated to equities and high-grade debt respectively — is down more than 10% this year, leaving it on pace for the worst drubbing since the 2008 financial crisis. . On the contrary, however, it is not only development that is of concern. Assets are being hurt by the risk that a stagnant economic expansion will be coupled with persistent inflation, a combination that could lead to poor returns – or even losses – for some time to come.

Market dynamics that occurred on Monday briefly captured the dilemma: Stock prices fell, but so did bonds, along with oil and other commodities. It was just day one, but it underscored how long-term dependent correlations can break down in the current environment.

“You can’t count on the kind of investment returns you’ve seen in history,” said Chris Brightman, chief investment officer at Research Affiliates. “Bond yields, dividends and earnings yields are at low starting points and this means that future returns will be lower than in history.”

This isn’t the first time analysts have questioned whether the 60/40 mix will hold, with some casting skepticism during the early months of the pandemic to see it deliver bigger returns as the stock bounces. Yet the combination of tighter monetary policy and rising consumer prices has warned investors that such gains are unlikely to be tolerated.

During the so-called “lost decade” of 2000, “the 60/40 portfolio generated a 2.3% annual return and investors would have lost value on an inflation-adjusted basis,” said Nick Cunningham of Goldman Sachs Asset Management, Vice President of Strategic Advisory Solutions. wrote in October.

“The very good returns of the past decade mean it’s important for investors to set more realistic return expectations,” said Isabella Goldenberg, US Head of Portfolio Strategy at Goldman Sachs Asset Management. He said this could include seeking returns in global equities and “in theory being diversified over the long term.”

The rallies of recent years were a boon for 60/40 portfolios, with rock-bottom interest rates pushing up both bond prices and stock valuations, especially those of high-growth companies. According to data compiled by Bloomberg, the mix delivered an average return of 18% from 2019 to 2021. According to Morningstar, since 2000, inflation-adjusted returns have been around 7.5% on a 12-month basis.

But the Federal Reserve’s plan to raise interest rates is now killing bonds, while higher oil and commodity prices are dragging stocks down, raising the specter of a 1970s-style stalemate — both parts of the 60/40 strategy. Potentially rendering continued headwinds. The Nasdaq Composite Index is down nearly 20% this year, while the Treasury’s broad gauge has declined 4.7%, more than in any year since at least 1974. Investment-grade corporate bonds have also fallen and are headed for the worst quarter since 2008.

Andrew Patterson, senior economist at Vanguard Group Inc., said markets are in a period of low leverage for the 60/40 portfolio. He forecasts annual returns over the next 10 years will be “south of 5% and our estimates have been grinding in recent years, driven primarily by equities.”

The bond market is an important part of this. After an era of extremely loose monetary policy, a sharp drop in bond yields has meant that interest payments are doing little to offset the loss due to falling prices. And even at current levels, actual 10-year Treasury yields — or expected adjusted for inflation — remain below zero.

The simultaneous fall of equity and bond prices can be characterized by an inflationary shock. Jean Boivin, head of the BlackRock Investment Institute, said in a previous era of supply-driven inflation, government bonds failed to offset equity losses, as prices in both markets rose simultaneously.

“Investors will have to live with high inflation and this will challenge the role of government bonds in a portfolio,” he said. “It will be difficult for central banks to control inflation and even harder to contain it if economic growth slows materially.”

That inflationary threat has made other assets potentially more attractive than bonds. Pacific Investment Management Company recently recommended shifting a portion of a 60/40 portfolio to commodities to hedge against increased inflation. “When inflation rises, asset values ​​typically fall,” and “even a small allocation to commodities can improve the inflation protection of a traditional 60/40 stock/bond portfolio.” ,” it said.