The 60/40 stock/bond portfolio, which has functioned for years as the standard for investors’ asset allocation, is under attack.
No less than three major firms have issued reports in the last few weeks declaring it dead or ailing: Bank of America Merrill Lynch, Morgan Stanley and JPMorgan.
The prime reason for shoving aside the 60/40 strategy is lower returns from bonds. Bonds not only deliver less yield in developed markets than they have historically — including negative yields in many European countries — but they also have less potential for capital gains because rates are already so low. The 10-year U.S. Treasury note is currently yielding 1.94%; the 10-year German bund, -0.25%.
“Lower returns from bonds create a challenge for investors in navigating the late-cycle economy,” according to JPMorgan’s latest Long-term Capital Market Assumptions report — its 24th — written by David Kelly, John Bilton and Pulkit Sharma. “The days of simply insulating exposure to risk assets with allocation to bonds are over.”
Bank of America Securities strategists Derek Harris and Jared Woodard, in a new report, “The End of 60/40,” explain that bonds have functioned as a hedge against stock losses because their returns have been negatively correlated to stocks. That negative correlation prevailed over the past 20 years — though not the previous 65 — but could flip as policy makers attempt to boost growth, according to Harris and Woodard.
Morgan Stanley’s cross asset strategists Serena Tang and Andrew Sheets attribute the decline of the 60/40 portfolio to not only low bond yields but also limited stock market returns, which in turn reflect lower income, low inflation expectations and penalties on both higher-than-average valuations and above-trend growth that cannot be sustained.