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The Death of the 60-40 Portfolio

Posted: Tuesday, November 10th, 2020

Estimated Reading Time: 2 minutes

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One of the widely used investing concepts is the building of the so-called 60-40 portfolio. For decades, the 60-40 allocation rule dominated financial markets.

Effectively, it means that investors allocate 60% of their portfolios to the general, broad market. Moreover, the 40% remaining goes to fixed-income.

By the broad market, investors refer to large-capitalization companies or simply the S&P500 stocks. As for the fixed-income market, think of Treasuries and/or investment-grade bonds.

The idea behind the 60-40 portfolio is that it represents the ideal portfolio diversification. Stocks have historically generated bigger returns, so that explains the bigger chunk dedicated to equities. On the other hand, bonds act as a hedge during troubled times.

A recent study suggests that the 60-40 portfolio is more than obsolete. Moreover, it reflects that lost decades using the 60-40 allocation rule are more common than one thinks.

Consider the chart below, as most started with expensive stocks and bonds. The real yields used are the ones on the 10-year Treasury bonds less the twelve-months trailing CPI (i.e., inflation). Also, the 60-40 portfolio uses the S&P500, respectively, U.S. Treasuries, rebalanced monthly.

60-40 Portfolio

Rotating Out of the 60-40 Portfolio?

Yesterday marked one of the most interesting days since the coronavirus pandemic hit the Western world. For the first time since March, the world sees the “light at the end of the tunnel.” Science offers a solution for the pandemic in the form of a promising vaccine. The one announced yesterday is probably only the first one out of many that reached the third phase of testing. What it means is that the “work from home” or “stay at home” stocks may be in trouble.

Could it be that the entire tech stock is in trouble? If we check the valuation for most of the tech giants in the United States, we understand who benefited the most during the pandemic.

Is the COVID-Growth Rally of 2020 Over?

The big question for investors at this point is if the end of the pandemic, suddenly within grasp, means the end of the COVID-growth rally? Is the current tech sector in a bubble just like in 1999? If yes, then the 60-40 portfolio will not perform well in the period ahead.

After yesterday’s 7% jump, the European travel and leisure sectors are back to March levels. The same is valid in the United States.

Moreover, Dow Jones outperformed the Nasdaq 100 index by more than 5% yesterday. It triggers a warning sign because, over the past two decades, it only happened 19 other times. Curious to find out the period? You guessed it – at the bursting of the tech bubble in 2000-2002.

If that is the case, some investors may ditch the 60-40 portfolio and look for higher returns elsewhere. Emerging markets look as cheap as they did at the end of the 90s. Also, emerging markets’ currencies look cheap as well.

All investors need is a sell-off to trigger some margin calls on the Nasdaq 100. If panic selling begins, expect emerging market value stocks and currencies might come back strongly.

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