By James Mackintosh, The Wall Street Journal, Updated Jan. 15, 2023
Before getting into them, it is worth considering why 60/40 became the standard (some prefer 50/50 for a bit more caution, or 70/30 for a bit more aggressiveness). It gives an investor decent exposure to growth through the stock element, steady income from the bonds, and a cushion during recessions when stocks often fall hard and bond yields usually fall too, increasing bond prices. Plus, it is easy.
Last year, stocks were down big, and bonds lost money too…
The fundamental problem is that last year the Everything Bubble deflated. Stocks and bonds started out very expensive, as did TIPS and private assets, because they were priced on the assumption of very low interest rates. Once the Federal Reserve recognized reality, the assumption went out the window and prices plunged. With valuations back in the range of reasonable for both stocks and bonds, a 60/40 equity/bond split is a decent starting point for building a portfolio—even if those who worry more about long-run inflation, as I do, might add a little more inflation protection than comes as standard. [end quote]
The Federal Reserve never “recognized reality” – the reality that a Fed which arrogated to itself the right and power to control the time value of money by creating mountains of fiat money would lead to asset bubbles.
Jerome Powell has said that he wants the Fed to be restrictive “for a prolonged period” until they are sure that inflation will not resurge, then return to a “neutral” fed funds rate which neither stimulates nor slows the economy. This implies that the Fed will finally, for the first time in 20 years, eventually allow the market to set interest rates without interference (barring emergency action in a lender-of-last-resort crisis).
But that’s not a sure thing by any means. The bond market doesn’t believe it. The stock market doesn’t believe it.
I think it’s premature to say what will happen in 2023-2024.
The classic 60/40 portfolio ignores that cash (or cash equivalents, like short-term Treasury bills or short-term secondary market TIPS) are also an investment class until risk subsides somewhat.