By Davide Barbuscia
NEW YORK (Reuters) – U.S. stocks and bonds are moving in opposite directions, a phenomenon that could bring relief for investors hoping for a blend of the two asset classes to blunt declines in their portfolios.
Yields on the benchmark 10-year Treasury – which move inversely to prices – are down 28 basis points since May 9, while the S&P 500 has continued a tumble that has brought it to the cusp of bear market territory, often defined as a fall of 20% or more from its highs.
The shift has marked a reversal of how bonds and stocks have behaved for most of 2022, which has seen twin declines in both equities and fixed income, slamming investors using strategies such as the 60/40 portfolio to mitigate risk.
That strategy, which counts on stocks rising amid economic optimism and bonds strengthening during turbulent times, has gone awry this year as expectations of a hawkish Fed weighed on both asset classes. The BlackRock 60/40 Target Allocation fund, which follows a standard portfolio technique of keeping 60% of its assets in equities and 40% in fixed income, is down nearly 13% since the start of the year, its worst performance since it launched in 2006.
“The epicenter of this crisis … is starting to shift from bonds towards other risky assets,” said Pramod Atluri, fixed income portfolio manager at Capital Group.
As a result, the recent gains in bonds have helped take the edge off volatility in the equity market, benefiting investors with a 60/40 portfolio, he said.
Investors say the reversal in bonds has been spurred by shifting market concerns. Worries over sky-high inflation, which erodes the value of future cash flows, dulled the allure of bonds earlier this year and expectations of Fed tightening drove yields higher.
Those concerns have more recently been overshadowed by fears that the Fed’s aggressive monetary policy tightening will hurt U.S. growth, with several big Wall Street banks warning of increased chances of a recession ahead. The Fed has already raised rates by 75 basis points and markets are pricing in a total of nearly 300 basis points in increases by March next year – potentially the steepest tightening cycle since 1994.
“We went from inflation panic to recession fears increasingly being the cause for concern,” George Goncalves, head of U.S. macro strategy at MUFG said in a note this week.
The performance of the 60/40 portfolio has varied over time. A study by Goldman Sachs Asset Management last year showed that a portfolio with a 60/40 split between U.S. large-cap stocks and investment-grade bonds generated an inflation-adjusted annual return of 9.1% between 2011 and 2021, far above its long term average of 6%.
From 2000 to 2009, however, investors in the 60/40 portfolio would have lost money on an inflation-adjusted basis, averaging a return of negative 0.3%.
GSAM analysts wrote that elevated valuations and low rates gave investors “many reasons to be concerned that the 60/40 might be dead,” and recommended diversifying into assets such as emerging market equities and international small caps to boost returns.
Joe Davis, global chief economist and head of investment strategy at Vanguard, believes the diversification offered by bonds depends on the trajectory of inflation, even in a scenario of continuously elevated prices.
“Once inflation stops rising unexpectedly, the correlation between stocks and bonds drops dramatically, in a good way, so the diversification returns very quickly, even if the level of inflation is so high”, he said.
(Reporting by Davide Barbuscia, editing by Ira Iosebashvili and Nick Zieminski)