Peaking stock returns amidst low bond yields is a toxic mix for long-term investors.
Not long ago, I expressed my belief that the so-called 60/40 portfolios (60% in stocks and 40% in bonds), the bedrock of so many investors and investment advisors, was gradually fading in usefulness. That article from October 3 focused on recent trends in the 60/40 concept, which I think is oversimplified and over-prescribed for investors, especially those approaching retirement or retired already.
As the next step in alerting you to the other side of the 60/40 mantra, let’s take a very long-term view. When we do, we find a precarious position for stocks AND bonds (specifically, U.S. Treasury Bonds) which combine to make the next 10 years or so in 60/40 portfolios some very disappointing ones.
Don’t get too dizzy looking at the chart above. The top part shows the return of the S&P 500 over 10-year periods (in blue), while the orange line plots the yield on the 10-year U.S. Treasury Bond. Think of this as answering the question “based on how stocks have done the past 10 years, and where rates are now, how good or bad will the next 10 years be for stock investors?”
To make this easier to understand (I hope!) see the lower part of the chart. This simply takes the 10-year S&P 500 return from above and divides it by the 10-year Treasury rate shown with it. If we focus on that ratio, we see that it is currently near its highest rate during the entire time this chart covers…which is a lot of time. This study goes back to the 1960s, so it covers multiple bull and bear markets.
Look at the other major peaks in that S&P 500 10-year return / 10-year U.S. Treasury Bond ratio over the past 50 years or so. One peak occurred in the mid 1960s, just as the stock market’s 10-year return peaked at a level it would not reach again for about 2 decades. The next peak was in 1999, just before the Dot-Com Bubble burst, sending long-term stock returns from the high teens to negative. That’s right, the beloved S&P 500 can produce a negative return over a 10-year period. Many so-called “long-term investors” forget that, and human nature being what it is, I’d expect some to bail out the next time that happens.
The third peak in this ratio has been a situation of “multiple tops” during this decade. The ratio briefly peaked in 2013, and then again in 2016, and it currently sits at about 3.6%, close to a 50-year high. Why didn’t the market cave in earlier this decade? No one knows for sure, but my suspicion is that all of the suppression of interest rates after the Financial Crisis “rigged” the markets in a way that allowed the stock and bond bull markets to continue a few years longer than they should have. Now, they are both in “overtime” and that tells me that the eventual end of those cycles will be quite cruel to unsuspecting investors.
The current situation resembles the one from the 1960s and 1970s in that interest rates appear poised to move higher over the next decade. You can see on the left side of the chart what that did to stock returns and the ratio I am focusing on here.
If long-term stock returns are close to peaking, it’s up to bonds to carry the load in that 60/40 mix. But that is not only happening recently, it is unlikely to happen for several years in the future. When we consider the combination of rising rates and the 10-year return on stocks of over 11% annualized, the long-term investor should really think hard about whether that 60/40 portfolio mix is their best path to prosperity in retirement.
For research and insight on these issues and more, click HERE.
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