The first half of 2022 has been a historically bad time for markets, and the carnage hasn’t been limited to equities. While stocks and bonds have sold in tandem, investors who for years have relied on the 60-40 portfolio – named because it involves holding 60% of one’s assets in stocks and the remaining 40% in bonds – struggled to find respite selling.
Virtually all areas of investment (with the exception of real assets like housing and booming commodities like oil CL00,
) underperformed cash and cash equivalents, such as short-term Treasury bonds.
According to analysts at Goldman Sachs, Penn Mutual Asset Management and others, the 60-40 portfolio hasn’t performed so badly in decades.
“It’s been one of the worst starts to a year in a very long time,” said Rishabh Bhandari, senior portfolio manager at Capstone Investment Advisors.
Goldman’s gauge of the performance of the 60-40 model portfolio has fallen about 20% since the start of the year, marking the worst performance since the 1960s, according to a team of analysts led by the chief strategist of the global equities Peter Oppenheimer.
Government bonds were on track for their worst year since 1865, the year the US Civil War ended, as MarketWatch reported earlier. On the stock side, the S&P 500 ended the first half with the worst performance since the early 1970s. When adjusted for inflation, it was its worst period of real returns since the 1960s, according to the data from Jim Reid of Deutsche Bank.
This is a very unusual situation. Over the past 20 years, the 60-40 portfolio arrangement has worked well for investors, especially in the decade following the financial crisis, when bonds and stocks rallied in tandem. Often when equities go through a rough patch, bonds typically rally, helping to offset losses on the equity side of the portfolio, according to market data provided by FactSet.
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Matt Dyer, investment analyst at Penn Mutual Asset Management, pointed out that beginning in 2000 the United States entered a 20-year period of persistent negative correlations between stocks and bonds, with the exception of post-crisis period between 2009 and 2012. Dyer has illustrated the long-term correlation between equities and bonds in the chart below, which shows that the relationship started to change in 2021, before the start of tandem selling in 2022.
Individual investors generally do not have access to alternatives like hedge funds and private equity, therefore stocks and bonds are usually their most easily investable assets. Those choices, however, became problematic this year, as individual investors had essentially nowhere to turn other than cash or a commodity-focused fund.
Indeed, over the past six months, more than 90% of assets tracked by Goldman have underperformed a portfolio of cash equivalents in the form of short-term Treasury bills.
Institutional investors, on the other hand, have more options to hedge their portfolios against the simultaneous sale of bonds and stocks. According to Capstone’s Bhandari, one option available to pension funds, hedge funds and other institutions is to buy OTC options designed to be profitable when stocks and bonds fall. Bhandari said options like these allow his company to hedge both their stock and bond exposure profitably, because an option that pays only if bonds and stocks generally go down is cheaper than a standardized option that pays if only stocks go down. .
Guggenheim’s Scott Minerd warned of a dreadful summer ahead, while recommending investors look to real assets like commodities, real estate and fine arts, instead of stocks.
Is the 60/40 portfolio dead?
With the outlook for the US economy increasingly uncertain, analysts remain divided on the future of the 60-40 portfolio. Dyer pointed out that if Federal Reserve Chairman Jerome Powell follows through on a Change in monetary policy à la Volcker To rein in inflation, the positive correlation between stock and bond returns is likely to continue, as soaring interest rates will likely worsen the situation for bonds (which tend to sell off as rates rise). interest increase). Such a move could also hurt stocks further (if higher borrowing costs and a slowing economy weigh on corporate earnings).
President Powell reiterated last week that his goal of bringing inflation down to 2% and maintaining a strong labor market remains a possible outcome, although his tone on the subject has taken on a darker hue.
Still, it is possible that the correlation between stocks and bonds will return to its historical pattern. Goldman Sachs analysts have warned that if the U.S. economy slows faster than currently expected, demand for bonds could increase as investors seek “safe haven” assets, even as stocks continue to weaken.
Bhandari said he was optimistic that most of the pain in stocks and bonds had already passed and that 60-40 portfolios could recoup some of their losses in the second half. Whatever happens next ultimately depends on whether inflation begins to decline, and whether the US economy enters a punitive recession or not.
If a U.S. economic slowdown ends up being more severe than investors had anticipated, stocks could be more painful, Bhandari said. Meanwhile, on the rate side, it was all about inflation. If the consumer price index, a closely watched gauge of inflation, remains stubbornly high, then the Fed could be forced to raise interest rates even more aggressively, triggering more bond pain.
For what it’s worth, investors enjoyed some breathing room after Friday’s selloff as bond and stock prices rallied ahead of the holiday weekend as markets closed on Monday. The yield of the 10-year Treasury note TMUBMUSD10Y,
fell 7.2 basis points on Friday to 2.901%, after a recent high of 3.482% set on June 14, according to Dow Jones Market Data.
The S&P 500 SPX,
rose 1.1% on Friday to end at 3,825.33, while booking a weekly decline of 2.2%, according to FactSet. The Dow Jones Industrial Average DJIA,
also rose 1.1% on Friday, but ended down 1.3% for the week, while the Nasdaq Composite Index COMP,
gained 0.9% on Friday, losing 4.1% for the week.
On the economic data front, markets will reopen on Tuesday with the May reading on factory and basic equipment orders. Wednesday brings jobs data and minutes from the Fed’s latest policy meeting, followed by more jobs data on Thursday and a few speakers from the Fed. But the big data point of the week will likely be Friday’s payrolls report for June.