Under inflationary pressure, the traditional "60/40" investment portfolio strategy experienced its worst performance since the international financial crisis, but recently, this once highly sought after strategy has rebounded.
According to the data compiled by institutions, if the S&P 500 index and the US 10-year treasury bond bond are taken as the benchmark, the return rate of this strategy in November was 12%, the best monthly performance since December 1991.
Analysts say that recent economic data still supports the trading theme of a "soft landing" for the US economy, while inflationary pressures in the eurozone have also eased, reducing the need for the European Central Bank to further tighten monetary policy. As the global economic cycle approaches the bottom of this cycle, the expected returns on diversified assets may gradually return to an upward trend.
Deutsche Bank's macro strategist Henry Allen told First Financial reporters, "Market pricing reflects that investors seem to expect the macroeconomic situation in 2024 to be quite optimistic."
"The market expects the Federal Reserve and the European Central Bank to cut interest rates in the second quarter of next year, and then gradually lower rates for the remaining time." Allen said, "This optimistic sentiment supported a significant rebound in various assets in November."
Rebirth
One of the most classic allocation methods is to simultaneously allocate 60% of stocks and 40% of bonds in an investment portfolio. If the benchmark is to invest in the S&P 500 index and the US 10-year treasury bond bonds, this portfolio can stably obtain a yield of 10% to 20% in most years of the past 30 years. The background of high returns is long-term stable inflation, downward interest rates, and the subsequent long-term bull market in US stocks and bonds. In 2022, both stocks and bonds were dragged down by high inflation and aggressive interest rate hikes, resulting in poor performance of the 60/40 investment portfolio.
Recent major economic data shows signs of cooling in the economic conditions of the United States and Europe as they enter the fourth quarter. The ISM Manufacturing Index (PMI) for November in the United States was 46.7, weaker than market expectations of 47.8 and unchanged from October. In the third quarter, the annualized rate of US gross domestic product (GDP) was revised up to 5.2%, while core personal consumption expenditure (PCE) was revised down to 2.3%. At the same time, the year-on-year growth rate of core PCE in October decreased to 3.5%.
High frequency employment data shows that although the number of first-time applicants for unemployment benefits remains at around 210000, the number of people continuing to apply for unemployment benefits has risen to around 1.93 million, a new high since the end of 2021, indicating a sustained marginal cooling in the US job market.
The latest Beige book released by the Federal Reserve also shows a slowdown in US economic activity in November, and market entities have seen a deterioration in their expectations for the economic outlook for the next 6-12 months.
On the European side, the initial inflation data for November in the Eurozone showed that the Consumer Price Index (CPI) and core CPI both exceeded expectations and cooled down; The final value of Markit's manufacturing PMI in November was 44.2%, slightly higher than the previous value of 43.8%, but still in a severe tightening range.
The market's expectations for the global economy in 2024 remain unchanged, with the 10-year US Treasury yield hitting a low of 4.2%.
In this context, analysts believe that the 60/40 investment portfolio may once again become a feasible strategy. Morgan Stanley predicts that with the long-term expected return of various assets rising, the expected annual average return of the portfolio composed of 60% American stocks and 40% American bonds is expected to rise to 8% in the next 10 years, and the last time this peak was reached was in 2013. Meanwhile, the investment portfolio consisting of 60% European stocks and 40% European bonds is expected to achieve an average annual return of 7.7% over the next 10 years, a new high since 2011.
Inflation data remains crucial
Analysts say the key issue is whether the high correlation between stocks and bonds will return to normal. Over the past 30 years, the positive correlation between economic growth and inflation has been an important factor leading to a negative correlation between stocks and bonds. Rising inflation will erode bond returns, while the increase in stock returns brought about by economic growth can offset the decline in bond returns, and vice versa. However, in the context of the increasing popularity of artificial intelligence technology, economic growth and a decrease in inflation can be seen in the short term, which poses a challenge to the assumption that the returns of stocks and bonds will show low or negative correlation in the future.
Although long-term expected returns have rebounded, the current stock bond correlation is relatively high for the 60/40 strategy. The increase in bond volatility has exacerbated this concern.
The market continues to trade around expected changes in US inflation trends, which may switch back and forth between soft landing trading and tightening trading. If the upcoming inflation data does not slow down as expected, the shadow of the "stock and bond double kill" in October may once again strike.
Michael Hartnett, a strategist at Bank of America, stated in a recent report that looking back at the significant increase in total returns of 60/40 investment portfolios, a certain degree of pullback often follows closely.