What You Need to Know
- Traditional 60/40 portfolio total returns were down 15% this year as of Friday's close.
- Recent market declines improved valuations and the outlook for the 60/40 portfolio.
- There may be room for more diversification, given even better valuations elsewhere.
After decades of healthy performance, the traditional 60% stocks/40% bonds investment allocation has lost some support among portfolio managers and strategists over the past year, with some recommending investors add alternatives to the mix to achieve better returns.
In new market commentary, LPL Financial Asset Allocation Strategist Barry Gilbert and Equity Strategist Jeffrey Buchbinder make the case that there’s life yet in the 60/40 portfolio, given dramatically improved valuations following recent market losses. At the same time, they suggest that further diversification could prove advantageous for long-term investors.
“It may have been wounded this year, and took another blow on Friday after the hotter-than-expected inflation data, but we believe the losses in stocks and bonds this year increase the chances of positive outcomes going forward,” they wrote. “Long-term investors take note.”
The 60/40 portfolio certainly has had a tough year so far, Gilbert and Buchbinder explain. Based on the S&P 500 and the Bloomberg U.S. Aggregate Bond indexes, “the traditional 60/40 was down 15% as of market close on June 10 on a total return basis. If the year ended now, that loss would trail only 2008 as the worst year on record,” they said.
While equity market volatility often means gains for bonds, that’s not always the case, Gilbert and Buchbinder note. Low bond yields in 2020 and 2021 and this year’s bond losses, sparked by rising interest rates, have led many to speculate that the 60/40 portfolio is finished, they add.
This year’s steep declines, however, come with a silver lining, according to the strategists.
60/40 Valuations Better Now
“Recent stock and bond losses have improved valuations for the 60/40 portfolio considerably, based on a combination of the price-to-earnings ratio for the S&P 500 and the yield for the Agg. Valuations aren’t an effective market timing mechanism, but they are an important consideration for longer-term return expectations, and that picture has improved quite a bit,” they wrote.
“The time to talk about the death of the 60/40 portfolio was six months to a year ago, and even then it was probably exaggerated,” the two strategists continued. “The 60/40 portfolio may not get back to the level of returns we’ve seen over the last several decades, but over the last year the 10-year outlook for the 60/40 has improved by about 2 percentage points annualized in our view, about as big a one-year improvement as we’ve seen at any time in the last 20 years.”
The S&P 500 forward price-to-earnings ratio reached 21.2 at the end of May 2021, Gilbert and Buchbinder say, citing FactSet data. A combination of higher earnings and lower stock prices resulted in a 17.4 P/E ratio as of Wednesday, an 18% improvement — closer to 20% by Friday — they add.