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An important relationship between stocks and government bonds broke in September and inflicted the largest losses on diversified investment portfolios since last year’s pandemic market rout.
Signs that inflationary pressures could intensify weighed on consumer and business confidence. This helped trigger the S&P 500’s first monthly loss since January. Yields on Treasury bonds have risen as investors anticipate the US central bank may act to contain mounting inflationary pressure next year.
Losses in the two main asset classes drove a typical 60/40 portfolio of US stocks and government bonds down 3.5% in September. Never since a 5% drop in March 2020 has the 60/40 mix suffered such a significant loss, according to FT’s calculations.
The combination of falling stock and bond prices in September “is a problem for all investors and not just asset managers,” Seth Bernstein, CEO of AllianceBernstein told the Financial Times.
Over the past four decades, a 60/40 portfolio has provided investors with strong returns and lower levels of volatility. Strategy is a mainstay of retirement portfolios, and older savers often tip the scales in favor of bonds for their fixed income.
The appeal of a 60/40 strategy is how a controlling equity stake provides exposure to growth through increased corporate profits. A smaller slice of high quality bonds acts as a stabilizer in a portfolio, and their value has typically increased in times of market stress for stocks.
In the decade from 2010, the 60/40 portfolio provided an annualized return of 10.2 percent and provided investors with a gain of 15.3 percent last year.
A period when the prices of Treasury bonds and stocks fall together “ultimately depends on whether current inflationary pressures are a transient or persistent phenomenon,” BCA Research said.
Bernstein warned that investors should prepare for greater market volatility and have had to contend with much lower returns by holding a diversified portfolio of stocks and bonds over the current decade.
“The 10-year yield can easily reach 2 percent,” and “investors are entering a period of much greater volatility for bonds given the uncertainty over inflation and the low income they now provide.” Bernstein said.
As the 60/40 mix gained 8% in 2021, a challenge for investors with a combination of stocks and bonds is that both markets are high in price, limiting the scope for future gains.
“It is mathematically impossible to repeat the portfolio record 60/40 over the past decades because rates are now so low,” said David Giroux, portfolio manager at T Rowe Price.
Avant-garde last week updated their forecast of expected 60/40 returns for the next decade and their capital markets model has a median annualized gain of 3.8% through 2031. The median annualized return over the next decade. next decade for the S&P 500 is estimated at 3.2 percent. hundred.
“Our forecast today tells us that investors shouldn’t expect the next decade to look like the last, and they will need to plan strategically to overcome a low-performing environment,” wrote Joseph Davis, economist in chief at Vanguard.
This has prompted investors to explore owning alternative assets such as real estate and private credit in a balanced portfolio approach.
“I run a portfolio that rivals 60/40 strategies and it doesn’t contain treasury bills and we also think most stocks aren’t attractive,” Giroux said. The T Rowe Capital appreciation fund has utilities that pay 3% dividends, as well as leveraged loans and bank debt that are less volatile and should match the return on a riskier equity portfolio.
“Five years from now, I wouldn’t be surprised to see a 4% annual return for stocks,” Giroux said.
Bernstein said investors should hold fewer bonds and own more stocks in their portfolios. While this approach means tolerating greater portfolio volatility, having some exposure to bonds will help protect against a sharp drop in stocks.
“Everyone thinks about diversification, but it’s like owning fixed income or being in cash,” he said. “Alternative assets and hedge funds don’t provide the scale [of diversification] to protect a portfolio for many investors.