Does the traditional 60/40 stock and bond allocation have a future?
Over the last 40 years, bonds have been in a long-term bull market, as bond prices have risen while yields have fallen. Persistently lower interest rates over four decades have not only boosted bonds but have also acted as a tailwind to asset classes. With the benefit of rising stocks and bonds, the 60/40 allocation between each has been a bedrock of investment portfolios and served investors well. However, this trend has reversed leading to the question: Are we at a paradigm shift?
US Government 10 Year yields (%) and
The S&P 500 Index (1982 to the present)
Investors own bonds for yield and the benefits of diversification. 10-year US yields have fallen from over 15% in 1982 to just 0.63% today, a decline of more than 95%. To add insult to injury, real yields which factor in inflation, are negative. Investors are unable to rely on bonds to produce a return greater than inflation without substantial price appreciation in the bonds themselves. With 10-year yields at 0.63%, there is little room for bond prices to rise unless yields turn substantially negative.
For the past 20 years, stocks and bonds have held a negative correlation to one another. When stocks have gone down generally bonds have risen and vice versa. This relationship has meant investors could rely on bonds to buoy their portfolios during crises and bear markets. However, if you look further back in history, this negative correlation has not always been the case.
The long term correlation of stock and bond returns going back over a century is actually positive at approximately 0.20. The last decade has been a historical abberation with negative correlations greater than -0.60. However, from the early 1960s to 2000, stock and bond returns had a strong positive correlation.
We have seen the erosion of the efficacy in bonds in 2020. During the Global Financial Crisis, the S&P 500 reached its nadir in March of 2009 having lost -56.32% while bonds measured by the Bloomberg Barclays Aggregate Bond Index rose 7.15%.
S&P 500 Index and
Bloomberg Barclays Aggregate Bond Index USD Unhedged (Oct 2007-March 2009)
During the Covid-19 panic in March, the S&P 500 lost 33.61% at the low of March 23rd while bonds lost 1% over the same period.
S&P 500 Index and
Bloomberg Barclays Aggregate Bond Index USD Unhedged (February-March 2020)
Bonds have been a key driver of investment returns for decades. Offering attractive yields and low or negative correlations with stocks has been of particular value to an investor’s portfolio. With interest rates approaching zero and currently negative on a real basis, bonds no longer deliver yield. In addition, if the Covid-19 crisis is any indicator, bonds may not deliver price gains when investors need it the most. Alternative investment strategies like systematic macro and managed futures have been out of favor for several years as the equity bull market continues to break records. However, the next bear market could unfold with few places to hide. It may be time to revisit that 60/40 asset allocation.