Bonds Taking on Major Role in 60/40 Portfolio: McGeever – Reuters

By Jamie McGeever

ORLANDO, Florida – The past month in the financial markets has seen significant developments: a record spike in U.S. stock market volatility, near-certainty from the Federal Reserve regarding an impending interest rate cut, and the largest one-day decline in a company’s market capitalization in history.

Amidst this tumult, bonds have demonstrated remarkable resilience, once again proving their value as a conventional hedge in a diversified investment portfolio. This trend indicates a shifting economic landscape, with investors potentially turning away from equities—currently at near-record highs and historically deemed expensive—in favor of fixed-income assets.

If this trend continues, the traditional 40% bond allocation in the ’60-40′ investment portfolio will need to bear more weight.

However, the strong performance of bonds is not just a recent phenomenon. Yields on U.S. Treasury securities have generally been on the decline since April, as asset managers have been steadily increasing their long Treasury futures positions throughout the year to record levels.

According to reports, global bond funds have attracted approximately $425 billion in inflows this year, which is about $40 billion more than what global equity funds have drawn in. Data from U.S. mutual funds indicates that bond inflows year-to-date stand at around $315 billion, nearly four times greater than equity inflows.

This movement toward bonds suggests that investors may be positioning themselves for a surge in fixed-income returns that has yet to materialize. The ICE BofA Treasury index has only increased by about 3% this year, while equities have risen over 15%, even after recent fluctuations.

Yet, the balance seems to be shifting.

RETURN TO ‘NORMAL’?

The standard balanced portfolio theory posits that the 60% equity allocation is responsible for the majority of returns, while the 40% bond allocation can provide downside protection during market volatility and economic uncertainty. This strategy works best when equities and bonds exhibit a negative correlation during turbulent times. Until recently, the correlation between the S&P 500 and Treasuries was predominantly positive, as investors prioritized concerns over rising interest rates over growth.

However, this trend appears to have changed.

Strategists at Truist Advisory Services pointed out that core bond returns were positive during the S&P 500’s 8.5% decline over a three-week period ending August 5. In fact, the last instance of stocks falling more than 5% while bonds rose occurred over four years ago.

While one month does not establish a trend, markets may be at a pivotal moment: the primary concern for equity markets has shifted from ‘higher for longer’ borrowing costs to fears of a ‘hard landing’. Now, growth is the major concern, overshadowing inflation.

Recent market reactions to slightly negative economic data have been dramatic. Reports indicated a contraction in U.S. manufacturing activity in August, which has occurred nearly every month for the last two years. This news ignited a rush from stocks to bonds. The S&P 500’s 2.1% decline marked its largest single-day drop following an ISM data release since October 2022. Additionally, volatility surged in early August partly due to a slight increase in U.S. unemployment, altering the risk/reward dynamic of holding equities as the economic slowdown becomes more apparent.

So, what happens if a soft landing does not materialize and the economy tips into recession? Historical trends suggest equities would likely fall while Treasuries rise.

Conversely, if growth decelerates but the economy avoids a recession, history indicates both equities and bonds would likely rise. In either scenario, bonds appear to be the safer investment choice.

It is reasonable to conclude that if the ’60-40′ portfolio faces challenges in the upcoming months, it will not be due to bonds.

(The opinions expressed here are those of the author.)