The 60/40 portfolio, a long-standing investment strategy allocating 60% to equities and 40% to fixed income, experienced a significant setback in 2022, suffering a 19% year-to-date decline. This marked its worst drawdown since the 2008 global financial crisis, as both stocks and bonds tumbled in tandem, a rare phenomenon that challenged the portfolio's core assumption of negative correlation between equities and government bonds.
Despite recent losses and some commentators declaring its demise, the 60/40 portfolio is anticipated to make a comeback. The investment landscape is shifting towards a new environment characterized by two-way inflation risk, tightening monetary policy, and higher interest rates. This new environment is expected to create fresh opportunities, with projected long-term returns for a dollar-denominated 60/40 portfolio over the next 10 years rising from 4.3% to 7.2%, the highest forecast since 2010.
This improved outlook is attributed to several factors. Higher yields have re-established bonds as a viable source of income and a potential haven, with US 10-year bond return forecasts increasing by 1.6 percentage points to 4%. Equities have also become more attractive due to lower valuations; developed market equity forecasts jumped 3.6 percentage points to 8.40%, and emerging market equities increased 3.2 percentage points to 10.10%. Corporate profit margins are expected to remain resilient, contributing to the positive equity outlook.
However, some analysts express skepticism, questioning the portfolio's viability given historically high valuations for stocks and government bonds. Vincent Deluard, global macro strategist at StoneX Group, predicted 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 previous decade. Alternative assets like private equity, real estate, infrastructure, inflation-linked bonds, and dividend-paying equities are suggested as replacements or additions to a more diversified, "multicolored" portfolio, moving away from a sole reliance on US bonds and large-cap stocks.
BlackRock, for example, is reportedly avoiding the 60/40 portfolio despite recent rebounds in stock and bond markets. Analysts at Bernstein also noted that current valuations imply only about 5% annual returns for the S&P 500 over the next decade, with low bond yields offering little offset to poor stock market performance. This suggests that while the 60/40 strategy may see improved returns in the near future, its long-term efficacy and diversification benefits in the evolving economic climate remain a subject of debate among financial experts.
