The coronavirus crisis has punished the blameless across the world this year. That includes investors who did the supposed “right thing,” by keeping a balanced portfolio to fund long-term gains, just as the experts advise.
As the stock-market cascaded to its recent lows this month, the traditional portfolio of 60% stocks and 40% bonds suffered a greater than 20% decline from its peak value, for only the fourth time since World War II.
At last Monday’s low, this standard retirement allocation, as represented by the Vanguard Balanced Index Fund, was 22% off its peak Feb. 19 value – driven mostly of course by the 30% tumble in equity indexes that bonds only partially buffered. In fact, near the worst of the stock sell-off bonds were not offsetting the losses by rallying, as everything but cash was liquidated.
Upon request, Ritholtz Wealth Management research director Michael Batnick went back in history to track each time the 60/40 portfolio had taken at least a 20% hit. Such a decline struck initially at only the following points since 1945 (using month-end data for 60% S&P 500 and 40% five-year Treasuries): August 1974, September 2002 and January 2009.
The fact that the 60/40 autopilot approach has only retreated by 20% on a monthly basis four times in 75 years is itself a testament to the smoothing effects of offsetting equity-fixed income interplay.
What happened next after the prior 20% setbacks? Those months were all within months of the trough of major bear markets, though in each case the ultimate low for the stock indexes was still to come.
Batnick calculates that in those three instances in 1974, 2002 and 2009, it took between 10 and 20 months for this portfolio to recover back to its peak level.
An investor who kept to the disciplined approach and rebalanced holdings back to the 60/40 asset split at the end of the month when a 20% decline was first registered would have been positioned for attractive returns in subsequent years.
In those three instances, the average annual total return from the 60/40 portfolio was close to 12% over the following five years. That’s a healthy advantage over the very long-term average yearly return of around 9% for this asset allocation.
This is perhaps comforting, if not terribly surprising. Any investment discipline that triggers a move to take advantage of steep underperformance in one asset classes tends to be rewarded over time. And rebalancing after big declines in a blended-asset portfolio has generally been about buying nasty breaks in stock indexes.
Is 60/40 stance broken?
On a more opportunistic, shorter-term basis, strategist Terry Gardner of C.J. Lawrence last week noted that simply buying the S&P 500 the last three times it’s dropped 25% from a peak (1987, 2001 and 2008), as it did this month, has always led to positive returns over the next year – even though in none of those instances did the minus-25% level represent the ultimate low for stocks. Those returns one year out were 20% after 1987, 2.5% after 2001 and 18% after 2008.
Are there reasons to be skeptical that holding fast to the 60/40 stance this time will not fare as well as in past decades? Some investment professionals have discussed for some time that the essential premise of the 60/40 mix has been challenged due to extremely low bond yields that leave far less room for bonds to appreciate in an economic slowdown or crisis, mitigating their value as ballast to stocks.
Goldman Sachs strategists last week sounded a cautious note on this front last week with regard to the present market skid. “In addition to the sharper-than-normal equity correction, diversiﬁcation in 60/40 portfolios has been less good,” the firm said. “With bond yields at all-time lows now and close to the effective lower bound, there is little space for most [developed-market] bonds to buffer equity drawdowns.”
Stretching deeper into history, skeptics might note the 60/40 portfolio carried a 20% loss for longer stretches in the 1930s, when stocks stayed deep underwater during the entire Great Depression.
So perhaps the traditional asset mix will get less help over time from bond yields squeezing lower in tough times (barring a move to negative yields, which would create a whole other set of issues). Still, bonds can still serve the role as cushion against equity losses.
Rebalancing aided the bounce?
The entire issue of rebalancing is hardly just an academic issue. The impulse from pension funds and automated asset-allocation vehicles to shift hundreds of billions in assets from fixed-income to stocks was detailed by strategists across Wall Street and was at least one significant driver of the surge in the S&P 500 into Thursday’s close.
The S&P 500 at its low point last week was underperforming the Barclays Aggregate Bond Index by some 30 percentage points year to date. Bespoke Investment Group notes that this effectively turned a 60/40 portfolio into a 55/45 mix, requiring one of the bigger rebalancing moves in years.
Of course, to the extent that this mechanical reallocation is timed to the quarter’s end, it means one short-term tailwind for the rebound rally has just about abated, as the market bounce leaves the indexes less stretched and investors have celebrated fresh trillions of dollars in support from the Federal Reserve and Congress.
Strategist Tony Dwyer of Canaccord Genuity, who’s been waiting for a retest of last week’s low to get more aggressively positioned, noted Friday, “Over coming days, the market will not be as oversold, the pension rebalancing will be done, and the bulk of monetary and fiscal stimulus will have been announced.”
While those factors could present a test of the immediate resilience of the market’s attempted comeback, they don’t much alter the case for long-term investors to take what the market has served up with its swift retrenchment this month.