Resources/Weekly Insights

October 28, 2023

Farewell 60-40… You Won’t Be Missed

Doug Walters, CFA

Investors have been hard on the 60-40 portfolio for all the wrong reasons lately, but now could be a great time to ditch the old standard for something better.

Contributed by Doug Walters, Max Berkovich, David Lemire, Eh Ka Paw

There has been much talk about the demise of the famed “60-40” portfolio. Traditionally, this is a portfolio consisting of 60% US equities and 40% US bonds. While it is touted as a good representation of a balanced, diversified portfolio, its merits were always questionable. There’s a better way and now seems like a particularly good time to become a convert.

So why all the noise about a 60-40 portfolio lately? In 2022, stocks fell pretty sharply. The hope in holding bonds is that they would act to offset some of those losses, but bonds fell as interest rates pushed up. So, it was a double whammy. The 60-40 portfolio did better than equities alone but nonetheless had one of its worst years on record. And so began the 60-40 shaming.

What is crazy is that the 60-40 portfolio (even including its slide since 2022) is up annually 8.5% since the beginning of 2018¹. That’s a full 2.5% above its 25-year average of 6%. 60-40 holders should be rejoicing!

While we are amused at how quickly sentiment has turned on this former investing standard-bearer… it was never a well-constructed portfolio. So you will not find us coming to its defense. It suffers from:

Too much home bias (no geographic diversification).
Market cap concentration (no Small Cap).
Asset class gaps (like Gold).

A Better Way

There is a better way to build a balanced and diversified core portfolio and now appears to be an opportune time to take notice. An evidence-based, well-diversified portfolio, in our opinion, should include:

A focus on attractive “factors” with a track record of outperformance, like High Quality, Attractive Value, Price Momentum, and Small Size.
Geographic diversification in equities and fixed income, including developed and emerging market exposure.
Inflation protection – directly through Treasury Inflation-Protected securities (TIPS) and more indirectly through real assets like Gold.

Historically, such portfolios have been able to produce higher risk-adjusted returns than a traditional 60-40 and could be particularly well positioned now. Why?

The S&P 500 is expensive and has high concentration risk in mega-cap technology stocks.
International stocks, by contrast, are particularly cheap right now.
Some factors, like Value, appear to offer more upside as well.
Gold is a good store of value in uncertain times and has been trending up recently.

There is no certainty in investing, and no one can be sure what the future will bring. But a portfolio with a solid, evidence-based, well-diversified core is a great way to prepare for whatever may come.

1. Based on the total return of the S&P 500 (60%) and US Agg Bond Index (40%), rebalanced monthly.

6%

Return of a 60-40 portfolio over the past twenty five years.

Recently (since the start of 2018), the 60-40 portfolio has returned around 8.5%, begging the question as to why sentiment has turned so quickly on the traditional benchmark.

Headline of the Week

The Many Numbers for Inflation

First, we must choose CPI or PCE, then Overall or Core, and finally, a time frame (three months, six months, or one year). Many economic reports and media stories offer a dizzying array from the above menu. And each has had their moment in the sun of late. Given that the market has filtered just about everything through its implication for Fed rate policy, it probably makes sense to focus on Core PCE. Time frames can be more challenging to narrow down. One year gets the most attention, although the 3-month annualized figure has gained prominence.

The current picture offered across all three timeframes shows solid progress in bringing inflation back down to target. And that assessment largely has calmed markets that were concerned about another rate hike. While the Fed has not made any promises, they appear cognizant that previous hikes continue to work their way through the economy, and the recent moves higher for long-term Treasury yields may negate the need to push rates higher. Chairman Powell’s comment captures this thinking…”it may just be that rates haven’t been high enough for long enough.”

The Week Ahead

There is some chatter that the Bank of Japan might steal the limelight next week from the Bank of England and The Federal Reserve. While possible, can any of the central banks outflank Apple’s earnings?

A Ghost from the Past

Rates have not been this high since….

Japan’s yields have not only turned positive but are now at decade-highs.
The Bank of Japan has already had to intervene with “special operations” as rates move higher. Fittingly, on Halloween, the Bank of Japan will have to serve up either a trick or a treat for global bond markets.
The Dollar/Yen exchange rate is hanging around 150 level for now.

The Invisible Man

Chairman Powell, who is accustomed to the spotlight on Fed Day, may be the invisible man, as the bond market might have done his work for him.

U.S. longer-term rates continue to dance around the 5% level, and mortgage rates are around 8%, creating tight monetary conditions without the aid of Fed hikes.
There is always a chance, chairman Powell might stick his head out to spook the markets with talk of a December hike or any hint at what longer, in the “higher-for-longer,” phrase may mean.

The Nine Englishmen

The Bank of England is also due for a rate decision next week.

While notable progress on inflation has brought it down from 9.1% at the start of the year, U.K.’s inflation is still running hotter than in the States and the Eurozone, but tepid growth should keep the bank on the sidelines.
Can the nine-member committee craft a statement to keep cooling inflation without tipping the flatlining economy into a recession?
The Bank of England has hiked rates 14 times already!

The Working Man

After the Federal Reserve’s meeting, Friday is the non-farm payroll report.

Early expectations are that the economy added 185,000 jobs in October, but expectations were crushed last month with 336,000 and revised higher for the month prior to that.
The strong Jobs report is not good for the inflation battle.

I Want Candy, Not Fruit!

Earning season continues the parade, with notables like McDonalds (MCD), Pfizer (PFE), Eli Lilly (LLY), Qualcomm (QCOM), and Berkshire Hathaway (BRKA, BRKB), but Apple’s (APPL) earnings on Thursday night will be the most anticipated.

Since reaching a $3 Trillion market capitalization during the summer, Apple’s stock has slipped down.
The New product launch of iPhone 15 and other products lacked the sizzle needed to keep the $3 trillion valuation.
Negative headlines from China for the company (20% of revenue comes from China) did not help.
Expectations seem muted going into the report, so any positive development can help the stock price.

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