We hear of the imminent death of the 60:40 portfolio as interest rates normalise. At Tellsons we believe that the recalibration of asset prices in recent months – the worst start to a year for both stocks and bonds in generations is a welcome ‘burning of the leaves’, a purging of the distorting excesses of the post GFC policy support. It is a cleansing of capital markets for the proper functioning of the business cycle and effective pricing of risk. It also restores the long-serving utility of the world’s favourite asset allocation – the king 60:40….or maybe the Queen, in service just as long and in recognition of her upcoming Jubilee.
The US Federal Reserve is in the driving seat for much of the global economy but with US growth, interest rates and inflation each in their primary focus. They need to sustain the economy and the corporate sector is looking strong. They need to implement rate hikes as much as the market is now expecting from them. And they might bend peak inflation back downwards over the coming months, as market-based inflation expectations consistently indicate they will.
In this context, the 60:40 asset allocation looks healthier and more sustainable than at any point in a generation. Bond yields in the US are back into the long-term ‘normal’ range of 3-4%, normal on an eighty-year view that is, and arguably rendering them investable for that ‘growth-off/risk-off’ utility they have always served in the 60:40 construction.
The more investors doubt this perfect scenario in the near-to-medium term, the more they should want the combination of income generating bonds to substitute for lower growth and the ever-present risks of market shocks, complemented with the dividends and earnings growth that strong companies can still generate from their pricing power and cost control.
If we think of the 60:40 as a through-cycle ‘growth-on/growth-off’ and ‘risk-on/risk-off’ portfolio construction, now is a time when its utility can be perhaps better illustrated than at any point since the global financial crisis. Our own Endeavour Fund is as good as any to make the point: Bonds here account for around 40% of the Fund, spread between relatively short duration corporate bonds and long duration government bonds, mostly in US Dollars with a combined yield of almost 4% and some inflation protection too.
Combine these with a 55% equity allocation at an average 18xPE, EPS growth of 12% and dividend yield of 2.5% diversified across: interest rate sensitive banking, energy and materials stocks for continued inflation pressures at an 8xPE; defensive healthcare, staples, communication services and utilities stocks with inflation pass-through pricing models for any downturn in the business cycle at a 19xPE; and a modest, high-conviction, secular growth allocation with consensus earnings estimates still intact after this reporting season of around 20% at a 31xPE.
The result is plenty of growth in a slowing growth world and more growth if it reaccelerates. It is also a lot of inflation protection in a high inflation world. It is a useful organic income yield of c.3%. And it is 70% of defensiveness if we roll off the end of the cycle altogether.
If TINA has been the only option in a low-rate world for the past few years – There Is No Alternative to equities – then now maybe it is ‘TRINA’: ‘there really is no alternative’ to the 60:40.
Rumours of its death may be looking increasingly exaggerated as bond-stock correlations revert to their longer-term relationship, putting a bit more stability and yield into client portfolios during these uncertain times.
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