Is the Golden Age of the 60/40 Stock Bond Allocation OVER?
By Eliseo "Jojo" Prisno, CRPC, MS
Chartered Retirement Planning Counselor
PE CAPITAL INVESTMENTS
Mid last month when the FED chair made certain that interest rates could remain where they are given the current economic situation, a reverse from what seemed clear a few weeks back that interest rates could potentially increase this summer, it outright created a jolt in the financial markets. The FED’s current narrative of being flexible seemed to be the new normal and this scenario will remain for quite some time. Given this backdrop, the traditional 60/40 stock/bond allocation, long the linchpin of portfolios, is broken, and it’s not coming back together any time soon.
As investors, what do we do?
Though, the 60/40 portfolio is actually having a decent 2016 (so far). A 60% allocation to the SPDR S&P 500 ETF (SPY ticker symbol) and a 40% allocation to the iShares Core US Aggregate Bond ETF (AGG ticker symbol) would be up about 3% year to date, however looking ahead, the math doesn’t work out. This is according to Charles Sizemore, a Wall Street portfolio manager and contributor to Economy & Markets Daily. If we look at the numbers, back in 1980, the 10-year Treasury yielded a whopping 11.1%, and stocks sported an earnings yield (calculated as earnings / price, or the P/E ratio turned upside down) of 13.5%. This implied return of about 12.5% per year going forward, proved to be a conservative estimate for much of the 1980s and 1990s. The 60/40 portfolio was a great allocation for the nearly four decades leading up to today.
But what about today? The 10-year Treasury yields a dismal 1.6% and the S&P 500 trades at an earnings yield of just 4%. That gives you a blended portfolio expected return of an almost embarrassing 2.8%. That’s just barely higher than the rate of inflation. According to Mr. Sizemore, nothing about these returns estimates is set in stone. It’s not impossible that stocks could continue to enjoy future returns more in line with their past returns, however improbable it might be. But unfortunately he does not say the same for bonds. Starting at a 1.6% yield to maturity (or even the 4% you might find on a mid-grade corporate bond) it’s impossible to have returns going forward match anything close to the returns of the past.
So, if the traditional 60/40 portfolio is dead, what are investors supposed to do with their money?
Mr. Sizemore offers the following suggestions:
1. Take a more active approach to investing.
To the extent you invest in traditional stocks and bonds, don’t be a buy and hold investor. Instead, try a more active strategy, perhaps focusing on value or momentum.
2. Invest outside the market.
If you’re willing to get your hands dirty, consider starting your own business. Some of the best business ideas were born in very difficult economic times. Yes, starting your own business is “riskier” than working for a paycheck. But having a day job isn’t exactly risk free… just ask anyone who works in oil and gas today.
3.Consider a truly alternative asset allocation.
The 60/40 portfolio has stood the test of time. Or has it? That’s actually pretty debatable, according to Mr. Sizemore. In the 1970s, both stock and bond returns were terrible. In any event, today’s market is fundamentally different than those in decades past. We’ve never been in a world of negative interest rates and central-bank-driven economics. A different era needs a different allocation.
For a long time, Mr. Sizemore had been advocating to using market-neutral and long/short strategies in lieu of bonds. A well-constructed long/short portfolio will do a lot of what you would want a bond portfolio to do; it will reduce volatility and give you a stream of returns that are mostly uncorrelated to the stock market. In a long/short portfolio, you buy stocks that you expect to rise in value and sell short stocks that you expect to fall. But since your portfolio is roughly balanced, you’re pretty well insulated from broad market moves. Your portfolio wins or loses based on the movements of the individual stocks. Whether the market goes up, down or sideways doesn’t matter much.
Will a collection of strategies like these beat the returns of a 60/40 portfolio in the years ahead? We’ll certainly find out soon enough. But the way I look at it (and this is Mr. Sizemore view as well), at least they give you a fighting chance to earn a respectable return.
If you want to invest in stocks and bonds portfolio work with a financial professional properly licensed to deal with the stock market. They need not be registered brokers or broker/dealer representatives, registered investments advisors are sometimes a good fit especially if you’re an active investor.
ABOUT THE WRITER: Eliseo Jojo Prisno is a Chartered Retirement Planning Counselor (CRPC).He founded P/E Capital Investments in 2010, a State Registered Investment Advisory Firm (CRD# 172695) and is currently the firm’s Managing Director and Senior Investment Advisor. Mr. Prisno also manages a Fund of Funds investment program with Ameritas and runs an All-Equity Growth and Income customized portfolios in separate accounts via E*Trade Securities. If you have questions email j.prisno@PEcapitalinvestments.com or call 1-888-929-2825. Visit our website www.PEcapitalinvestments.com