Unplug & Check it: The “60-40”
I am BACK… to blogging. Look out, world! Apologies – but I fell victim to a severe case of “writers block.” No – seriously. For about four months, I would sit down with all the intentions of writing a blog… but was never able to really produce anything with substance. In some cases, I wouldn’t get further than a sentence or two.
And then it happened – I unplugged for about 72 hours. Unplugged from work. Unplugged from my laptop and cellphone. Unplugged from that one side of the brain that says, “go, go, go,” and instead listened to that (smaller) voice inside my brain that said, “slow down, and look at what’s right in front of you.”
Right… in front… of you.
And over Labor Day weekend, that “right in front of me” happened to be the northwest quadrant of the Adirondacks along the Oswegatchie River for two days and two nights (my only regret is that it wasn’t two days longer!). Just my closest family members and I, in the quiet and serene Adirondack Wilderness.
It was so amazing and yet -- I never even knew I needed it!
So, if you’re feeling anything like I was before this past weekend - perhaps feeling regretful or restless that the summer has passed you by or finding that you’re not as productive at work as you’d like to be -- give yourself permission to unplug, just one last time.
You can tell your boss… “well I’m sorry but I read that I should unplug somewhere on a blog…”
But back to reality, as our summer draws to a close, and as the morning air is beginning to feel a bit more… crisp. I’ve taken notice - there are some changing themes underneath broader stock market indexes (whether these trends have legs is another story) but if you’re just catching up with stocks and bond prices / performance over the summer, here’s how they’ve performed during the month of August and year-to-date:
All returns are from S&P Global, except for ACWI Ex-US, which is from MSCI, Inc.
We had a blip on the radar for August, especially for international stocks, while Large Cap domestic stocks (at least among the S&P 500) reestablished some type of level of support somewhere around ~4370, but not before that index traded down 4.1%, from peak to trough (trailing 3-months, per yahoo finance). A 4% drawdown for the S&P is not an insignificant amount of volatility, but pales in comparison to the average historical intra year decline, which is still (on average) 14%.[i]
International markets performed much worse in August, as the news of China’s slowdown permeated, followed by a grim outlook for the Eurozone. Europe has been hit hard with inflation – in August it was still growing at a 5.3% annual (year-over-year) pace – well above the ECB’s 2% target. So, there’s potential for both a slowdown, and a hard landing, for international markets.
So now what? We can spend a lot of time pontificating on how the stock or bond market might perform in the future, but for this blog post - I thought I’d help readers zoom out more and revisit the bigger picture.
Specifically, I thought it might be interesting to look at how the “60-40” portfolio performed over the past 20 years or so, and “put to the test” a few “rules of thumb” over that period (such as the 4% withdrawal rate). For this exercise, I chose the S&P 500 for the 60% stock, and the Barclays US Aggregate Bond Index for the 40%. Here are those results:
If you were to have invested $1mm in 2002 and stay invested through 2022,
and if you were to have withdrawn 4% at the end of each year;
your portfolio would still be worth $1.69mm today,
(before taxes or investment management fees)
while also providing $1.1mm worth in withdrawal “income.”
Not too shabby at all. If your expectations were that the portfolio should provide some income to help cover your expenses gap after Social Security, and for the value of your portfolio to either have stayed the same or gone higher… you’d be pretty happy!
So, what’s the problem? Well, certain allocators are starting to sound the alarms, when putting together financial plans for the next 20-30 years, using return assumptions & inflation assumptions. More specifically, for clients to reach their goals: what should that allocation look like, for the next 20 years?
It’s a good question. When you look at the backdrop we find ourselves in today, versus the backdrop with which stocks and bonds were able to perform, these past 20 years: today’s forecast looks much different. Here is that present-day backdrop:
Higher inflation.
Higher interest rates.
Margins compressing, for reasons like higher labor costs, affecting corporate earnings.
And at face value, how do stocks and bonds… for lack of a better word… look?
The forward price over earnings (p/e) multiple is 18.85 for the S&P 500, while the 25-year historical average is 16.8x.
As of June 30th, the top 10 names account for 30% of the index, and they are more expensive, with a p/e of 30.5x (Capital IQ).
Meanwhile, the US 10-Year Treasury is paying 4.1%– its highest level since 2007!
International stocks, as tracked by the MSCI ACWI ex-US, are trading at 12.5x forward p/e.
What is MSCI ACWI ex-US? Per their website, “The MSCI ACWI ex USA Index captures large and mid-cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 24 Emerging Markets (EM) countries. With 2,306 constituents, the index covers approximately 85% of the global equity opportunity set outside the US.”
So, in a way and at first glance – international stocks look like a bargain relative to domestic stocks, and investment grade bonds look more favorable than 15 years ago. So, we should just overweight international stocks over domestic ones, and own more bonds. Right?
Not so fast. Those three asset classes (US Stocks, US Investment Grade Bonds, and International Stocks) all have glaring weaknesses and headwinds moving forward. Yes, someone said that 15-20 years ago. Yes, I realize I collect fees over assets which I allocate for people (but I only wish for you to take this information and do with it what you will…).
The 60-40 is not dead, by any means… but it does need to be… reworked, and the traditional monte carlo equation has flaws (more on this, in a different blog post). Allocators, today, must consider:
The trade-offs of going more international over domestic, including heightened geopolitical risks.
Whether 20% alternative investments are enough.
Whether the alternative investments should only substitute bonds; or whether they should also be a substitute for stocks as well (i.e., should it be 60-20-20 stocks – bonds – alternatives… or 50-25-25?).
I’ve already discussed in my Q3 Letter to Investors: I think alternatives are here to stay in portfolios, for much longer than originally anticipated; to help complement the more traditional aspects of international stocks, domestic stocks and bonds. But choosing which alternatives takes a higher level of investment experience (i.e., you wouldn’t want to own a put-write strategy, during periods of muted volatility…) as these investments do not easily present themselves as a “plug and play” investments, like traditional asset classes do.
All reasons to have a more critical conversation with your advisor. If you’re ever left feeling, after an annual review with your advisor, that it was just the “same old same old,” then some alarm bells should be sounding off in your head.
Why? Because the next 20 years hardly ever repeat the last 20.
[i] JP Morgan Guide to the Market – Slide 15 – Aug 31st, 2023.
