Joe Lucey

The “60/40” portfolio, made up of 60% equities and 40% bonds, has been a staple of investment management for several decades. The strategy gained mainstream acceptance after William Sharpe and Harry Markowitz won the Nobel Prize in Economics in 1990 for this portfolio optimization model. Mutual funds further popularized the investment strategy in the late 1990s and early 2000s. And it worked well for the better part of the past three decades, but is it still relevant today?

So, Why 60/40, Anyway?

The 60/40 portfolio has become the generic term for a diversified portfolio, with the mix between stocks and bonds varying based on the investor’s risk tolerance and goals. Stocks are held in hopes of capital appreciation growing the portfolio and maintaining purchasing power against inflation, but they also carry varying amounts of risk. Bonds, used in conjunction with stocks, provide safety and reduce volatility. Bonds worked well in portfolios in the 45-year period leading up to 2020, at which time interest rates steadily decreased. This period saw bond prices rise (as bond prices move inversely to yields), providing investors with income and rising values. Government bonds, in particular, acted as a strong equity hedge during the Great Financial Crisis of 2008 as interests quickly dropped while investors sought safety in U.S. Treasuries.

Recent Underperformance and Challenges

However, things have changed. Over the past few years, portfolios with a mix of stocks and bonds have underperformed due to rising interest rates pushing down bond prices. In response to inflation spikes post-COVID, the Federal Reserve raised short-term interest rates, resulting in some of the most significant bond losses of the last hundred years. The so-called “safe money” in bonds has not fared well over much of the last three years. While stocks have generally performed well, bonds failed to provide the expected protection during the stock market downturn of 2022.

The Outlook for Interest Rates and Bonds

Current expectations suggest that interest rates will drop, pushing bond prices higher, and enabling the traditional stock/bond portfolio to regain its strength. However, we are not fully convinced that this will be the case. The yield curve has been inverted (short-term rates higher than long-term rates) for nearly two years. When (if) the Fed does lower rates, the yield curve will likely normalize, with short-term rates dropping and intermediate to long-term rates holding steady or even rising. Short-term bonds will likely provide a positive return but those gains may be somewhat limited since gains in bond prices may be offset by the reduction in interest received as a result of lower rates. Long-term bonds offer limited upside, outside of interest paid, if long-term rates hold steady and create potential for further losses if rates rise.

Despite these challenges, fixed income yields are at their highest levels in nearly 20 years, so investors get “paid to wait” and collect interest. However, after accounting for taxes and inflation, real returns on many fixed income instruments are minimal and barely maintain purchasing power.

Adapting With Changing Markets

A diversified asset portfolio still makes sense to lower volatility and preserve capital. However, asset allocation should be dynamic and adjusted according to current economic and market conditions. Modern Portfolio Theory, introduced by Markowitz in 1952, was based on three asset classes: stocks, bonds, and cash. Today’s investment landscape offers considerably more strategies and options for generating income and protecting against stock market losses than there were in the past.

Secured Retirement Will Explore Your Options

If you haven’t already, it may be time to look beyond the traditional 60/40 portfolio and consider alternative strategies. There isn’t a single right or best way to build an asset allocation, but mistakes can lead to poor outcomes. With the help of a knowledgeable professional, each investor needs to find the balance that best aligns with their unique goals and objectives. If you’re struggling to find your balance, give us a call: 952-460-3290.

After a hot first quarter, we’re left feeling that the market has begun to cool off just as the weather warms up here in the upper Midwest. With a mix of rising interest rates and tempered expectations for Federal Reserve rate cuts, we’ve begun to feel a slight market chill. Nevertheless, and despite some hubbub over inflation and interest rates, we believe the market will remain healthy. Our very own Chief Investment Strategist, Nate Zeller, breaks down why.

Q1 and Q2 In A Few Recording Breaking Numbers

Wall Street continued its hot streak in March, extending its rally to a fifth straight month.  The S&P 500 returned over 10% in the first quarter of the year; the best first-quarter performance for the index since 2019!

The second quarter has gotten off to a cool start for stocks as interest rates moved higher. Following comments from officials at the Federal Reserve, expectations for the number of interest rate cuts this year were damped, sending bond yields higher. Yields on 10-year U.S. Treasury bonds recently touched their highest point in 2024. 

What’s To Come of The Fed’s Hold Steady?

Investors remain cautious about the pace of the Fed’s rate-cutting timeline this year and how soon central bankers will be able to meet their 2% inflation target. As expected, the Fed held interest rates steady at their March meeting and officials have indicated they are in no hurry to cut as economic growth remains strong and inflation remains above target. 

Many “experts” and prognosticators on television and the internet would lead us to believe that if the Fed does not cut rates this year it could spell disaster for the stock market. We do not think this is the case, and, in fact, believe the opposite to be true. If the Fed does not cut rates, it is because economic activity and the labor market remain strong. Economic growth generally leads to corporate earnings growth, helping provide a tailwind for stocks. The Fed cutting rates as a result of slowing economic growth could be a bad omen for the stock market. 

An ideal scenario would be lower inflation while the economy remains healthy, but this may be unlikely since robust economic growth typically leads to inflation. There is also the prospect that inflation reverses course and moves higher, forcing the Fed to raise rates. While this may seem doubtful, it does remain a possibility, especially in light of the recent rise in commodity prices – namely oil.  

An Overvalued Stock Market and Broadening Momentum

Indications signal the overall stock market is overvalued when compared to historical measures. The question is whether earnings will continue to grow to support lofty share prices or if prices will fall to be more in line with long-term averages. Nothing mandates that stock prices must trade at certain valuations and, as we know, the market can remain irrational for a very long time. However, over time, the market always seems to “revert to the mean”, so eventually, we are likely to see either a pullback in prices or an acceleration in earnings growth.

The emergence of the “Magnificent Seven” stocks last year led markets higher but not all stocks and sectors participated in the rally. The performance of the major market indices was primarily driven by these seven stocks which now make up a large concentration of cap-weighted indices.  Currently, there is added risk in investing in passive strategies that track these indices, since they are heavily weighted to this small handful of stocks. 

We are not necessarily expecting a pullback in these names, since most are very strong companies with solid and rapidly growing earnings, but we do anticipate a broadening of the upward momentum to include a wider array of stocks in sectors outside of technology which will provide opportunities for active management strategies.   

Protection Strategies To Mitigate Your Investment Risk

With the stock markets trading near all-time highs and a sense the market is overbought, we fully understand there may be some trepidation amongst investors when it comes to putting new money into the market. Remember, stock market investing is a long-term endeavor and there are times of volatility.  Historically, patient and disciplined investors have been rewarded.  There are many protection strategies available which provide stock market participation while protecting against downside risk. If you’re interested in learning more about how various strategies might make sense for you, give us a call at 952-460-3290.