The Death of the 60/40 Portfolio
We had the pleasure of hosting Jared Woodard, Head of the Research Investment Committee for Bank of America Research, on our Behind the Markets podcast last week.
When we get to the other end of the pandemic, Woodard’s team has three scenarios in mind for financial markets.
- Stagnation: A path of low growth, wages, interest rates and profits for most companies and relatively few winners in the markets. This is the world of secular stagnation we have been in for the last decade or two.
- Stagflation: One catalyst that could spark higher inflation with low growth might be a changing relationship with China, not just in the U.S., but around the world. It also could come from more regulation of the technology sector.
- Elevation: A world of higher growth, higher productivity and maybe demand-based inflation (which is the good kind). If world leaders start investing more intentionally in capital expenditures and research and development, there are many examples in modern times of private and public sector partnerships that powered innovation higher. Many of the components of smartphones came from Cold War spending that led to long-run innovations. There would be nothing more bullish than this cooperation for new investments where we can see higher growth.
The World Is Just One Trade Today
Whether it is growth versus value, large caps versus small caps, U.S. markets versus foreign markets or the drop in bond yields, all things that are leading the market are correlated to the lack of profit opportunities and very narrow growth leaders. The risk to this market setup is if we have a breakout in inflation coupled with a growth surprise that would shake up the incredibly crowded and expensive assets and turn toward the real losers over the last two decades.
The Death of the 60/40 Portfolio
The biggest takeaway is that Woodard’s team is more confident than ever that we hit the low in interest rates this year and will likely see them move considerably higher in the future, arguing that investors should start to move away from bonds in their current allocations.
Woodard’s team also believes the standard hedging function and diversification benefits of bonds will be much less attractive going forward. Right now, the 10-year U.S. Treasuries are trading at 75 basis points (bps), while the market is pricing in inflation over the next 10 years at 1.7%. Investors are locking in real, after-inflation purchasing power losses and essentially buying bonds as “insurance” against an equity market decline.
To Woodard and his team, bonds have become expensive insurance against equity declines, particularly if bonds will no longer maintain their diversifying properties with these very low rates.
Treasuries can also become a source of risk in portfolios if we start to get inflation heading higher, combined with positive surprises on economic growth. The takeaway: There are better places to allocate capital than long-term bonds, and there are better ways to structure portfolios.
Where to Put Risk Capital to Work
There are three types of risk in their simplest form: equity risk, credit risk and interest rate risk. The other two types of risk are more attractive than interest rate risk, and Woodard likes taking on some prudent credit risk.
This was a great conversation on the key challenges for most investors today. You can listen to the full conversation below.
Jeremy Schwartz has served as our Global Chief Investment Officer since November 2021 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity Indexes, quantitative active strategies and multi-asset Model Portfolios. Jeremy joined WisdomTree in May 2005 as a Senior Analyst, adding Deputy Director of Research to his responsibilities in February 2007. He served as Director of Research from October 2008 to October 2018 and as Global Head of Research from November 2018 to November 2021. Before joining WisdomTree, he was a head research assistant for Professor Jeremy Siegel and, in 2022, became his co-author on the sixth edition of the book Stocks for the Long Run. Jeremy is also co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” He received his B.S. in economics from The Wharton School of the University of Pennsylvania and hosts the Wharton Business Radio program Behind the Markets on SiriusXM 132. Jeremy is a member of the CFA Society of Philadelphia.