60/40 Blend May Rebound This Year: Wells Fargo

The 60% stock/40% bond portfolio may be primed for a healthy rebound in 2023 after taking a drubbing in last year’s market, according to Wells Fargo, which anticipates a solid recovery for the S&P 500 Index.

The Wells Fargo Investment Institute‘s 2023 forecasts for stocks and bonds “suggest that the 60/40 blend may potentially rebound from its double-digit loss of this past year,” the organization said in a note published Tuesday.

“Although we expect that stocks and bonds are likely to exhibit some near-term volatility, the midpoint of our year-end price target for the S&P 500 index this year is 4,400, or nearly 15% higher than its current level as of this writing, and that does not include dividends,” the firm wrote.

As far as the bond market, WFII believes long-term interest rates are approaching peak yields in this cycle. The firm recently upgraded its guidance on duration and long-term U.S. taxable fixed income to favorable and most favorable, respectively, and noted that 2022 marked the second consecutive down year for the bond market, which hadn’t happened in more than 60 years.

“U.S. bonds historically have never posted three consecutive years of negative returns,” WFII said.

Stocks and bonds this year should return to the negative correlation — moving in opposite directions — they experienced from 2000 until 2022, when the correlation turned positive, according to Wells Fargo. Rapidly declining inflation, combined with a peak in long-term rates, suggest bonds may provide beneficial portfolio diversification in 2023, the firm said.

A well-diversified portfolio that also includes commodities, which tend to rise with inflation, and alternative investment strategies with low correlations to both stocks and bonds “may help in an effort to limit investors’ downside exposure through choppy markets,” WFII said.

The traditional 60/40 arrangement sank 16.4% last year, based on the annual returns of the S&P 500 Index and the Bloomberg U.S. Aggregate Index, as the stock and bond markets retreated in sync, WFII noted. That’s its worst decline since the 21.6% slide the portfolio took in 2008, during the global financial crisis.

Historically, 60/40 portfolios experience strong performance following a negative year, according to WFII.

Among other points, WFII noted that the S&P 500 energy, materials and financial sectors over-earned their index weights for the year, while consumer discretionary under-earned.

“We expect the energy sector to continue to offer earnings power for the buck in 2023, while the financial and materials earnings power buffer should help these sectors in an effort to weather our expectations for an upcoming recession relatively better than consumer discretionary,” Wells Fargo said.

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