Morning Market Commentary:
This is the last in a series of comments we're highlighting from this past year. We think is key to the outlook for the S&P 500 Index in 2023. This piece originally ran on November 28 and 29. Enjoy!
- The 60/40 portfolio had one of its worst years on record.
- The strategy's annual return has dropped more than 15% in a calendar year only five other times.
- These previous instances have proven compelling buying opportunities for the S&P 500.
The 60/40 portfolio is poised for big returns in 2023...
Over the past 11 months, investors everywhere have become inundated with one phrase in particular: "There's nowhere to hide." This refers to the damage being done to both the stock and bond markets at the same time.
Investors and money managers have struggled to find profitable footing amongst a plethora of investing strategies. But none have been more scrutinized than the traditional so-called 60/40 allocation. The 60/40 portfolio is designed to provide a moderate balance between risk and return.
You see, historically, when money is moving out of stocks, it flows back into bonds. Typically, money managers would compare the yields on the S&P 500 Index with 10-year U.S. Treasuries. When the income payout in one is higher than the other, allocators would take advantage of the opportunity to move money into the asset with better return potential.
But with interest rates rising so quickly this year, the yield on both income-paying stocks and coupon-paying bonds has shot up. That's because investors have been uncertain of when the Federal Reserve would stop raising interest rates. As a result, the underlying prices of those investments have dropped. This has caused the 60/40 portfolio to drop more than 15% this year.
Yet, based on what history tells us, the previous five times this has happened proved to be a great buying opportunity for the S&P 500...
With 60% in stocks and 40% in bonds, these portfolios historically have been able to achieve high growth potential from riskier stocks while also shielding excessive loss through more conservative bonds. This popularized investment strategy largely relies on the fact that the stock market and the bond market rarely see dramatic drawdowns at the same time.
But this year, investors have endured the unlikely pain that accompanies a down year for both stocks and bonds. Year to date, a 60/40 portfolio invested in the benchmark S&P 500 and the benchmark U.S. 10-year Treasury bond has a real loss of 23.6%.
A real loss (or gain) takes into account the effects of inflation on nominal losses (or gains). In other words, higher inflation reduces the value of any gains and furthers the devaluation of any losses.
Only 1974 – another year plagued by high inflation – recorded a worse loss. A 60/40 portfolio saw a real loss of 24.11% that year.
As we said previously, a 60/40 portfolio of U.S. stocks and bonds has only finished the year down more than 15% just five times in the past 94 years through year-end 2021. And it appears this year will be the sixth time in 95 years...
With inflation on pace for its highest average annual rate in nearly 40 years, the Fed has embarked on one of the fastest rate-hike cycles in its history...
The result is a bond market that has struggled to gain any traction. (Remember, bond prices and interest rates/bond yields move in opposite directions.)
And investors fear that the Fed's aggressive dollar-strengthening moves to combat inflation could tip the economy into a recession – and result in even further declines in stock prices as investors exit riskier investments.
But don't lose hope just yet...
Yes, the 60/40 portfolio strategy may be having a historically terrible year. But history shows us that future gains are right around the corner. Let's look at the other five years where a 60/40 portfolio had an annualized real loss greater than 15%...
- 1974 – 24.11% loss
- 1937 – 22.85% loss
- 1931 – 19.86% loss
- 1946 – 18.57% loss
- 1941 – 16.74% loss
The table below shows the returns of the S&P 500 three, six, 12, and 24 months after each of the above-mentioned years...
The most notable outcome is that within two years, the market returned a total of 36.4% or 18.2% annually. And within only one year, the market had an 80% success rate with an annual return of 15.6%. That's not so bad when you consider it's nearly double the 9.1% average yearly return of the S&P 500 since 1928.
So, what does all this tell us?
The 60/40 portfolio strategy isn't "dead," and neither are your prospects of investment gains. A solid, diversified portfolio strategy is built for long-term gains. No allocation assortment is going to survive every short-term economic and market hurdle.
That's why we must keep our eyes on the horizon...
It's easy to get nervous and exit a trade too early or not jump in at all. Everyone's circumstances are different... So if that's what helps you sleep soundly at night, then so be it. But if you're focused on compounding your investment returns and growing your money over the long run, then the next couple of years present a compelling opportunity.
Investors have historically gained confidence following record market drawdowns. If inflation starts to fall and the Fed stops raising interest rates, uncertainty will fade. The change will spark a rally in bond markets. And with borrowing rates no longer rising at their current pace, investors will regain their appetite for risk assets like stocks.
That will serve as a major tailwind for equities and the S&P 500.
If you'd like to read more about Stansberry Research's thoughts on how to position your portfolio for the upcoming surge, check out Prosperity Investor here.