The traditional 60/40 investment portfolio, long considered a mainstay, is being questioned as some investors predict a decade of underperformance for both equities and bonds. With stocks and government bonds at historically high valuations, investors are exploring alternatives, leading to potential growth in other asset classes but also pushing long-term investors into unfamiliar territory. Vincent Deluard, global macro strategist at StoneX Group, anticipates a "nuclear winter" for the 60/40 portfolio in the 2020s, with inflation-adjusted returns potentially being a fraction of the 8.1% seen in the past decade, citing that low bond yields will not offset poor stock market performance.
Historically, the 60/40 portfolio generated a compound annual growth rate of 10.2% in the US since 1980. However, current equity valuations are historically high, with the forward price-to-earnings ratio for the S&P 500 at 21.7 times, significantly above its 20-year average of 15.4 times. Government bonds are also considered historically risky, as current low yields mean even small interest rate changes could lead to substantial price swings and potential losses if inflation rises. Analysts at Bernstein project approximately 5% annual returns for the S&P 500 over the next decade.
During 2022, the 60/40 model faced significant challenges as both equities and bonds experienced sharp declines. This happened because the fundamental assumption of a negative correlation between equities and government bonds, where bonds act as a stabilizer during equity downturns, broke down. Analysis over the past 60 years indicates that when inflation exceeds 2.5%, the correlation between bonds and equities shifts from negative to positive, causing them to move in the same direction, typically downwards during high-inflation, rising-rate environments. This is precisely what occurred in 2022, leading to the 60/40 portfolio compounding losses rather than providing protection. Investors are now being advised to consider true multi-asset investing, including assets like private equity, real estate, infrastructure, inflation-linked bonds, and foreign equities, to achieve genuine diversification and independent return potential.
Despite the concerns, some argue that the 60/40 strategy has defied predictions of its demise, with a closely watched benchmark delivering an 11% return in 2020. They maintain that bonds will continue to play a crucial role by offering diversification and moderating portfolio volatility, especially given the likelihood of a bumpy global economic recovery. Historically, bonds have provided a steady return, averaging 4% over the past three decades from US Treasuries, contributing significantly to multi-asset portfolio returns with little capital loss risk. However, the efficacy of this "haven" status is being stress-tested in the current low-interest-rate environment.
