It’s a wild game in 2020, and we’re only starting the fourth quarter, with perhaps even more fireworks to come. This applies to markets and the political world alike.
5.57% for total return
S&P 500 Index
Hardly anyone narrates the story in the first nine months of the year. There were more memorable illnesses at the end of the first quarter following the outbreak of the coronovirus epidemic, and according to overall return data provided by Howard Silverblatt, 51.75% rebound from March 23 to the end of September, the S&P’s number maven. All of which followed his stomach and churn his F. 19 left the S&P 500 with just 0.47% return relative to the high.
But the past cannot be a good guide to the future. As I’ve written before, with bond yields at historical lows — 0.67% for the most recent 10-year Treasury benchmark — they have little room to fall and no limit to how far they can rise. Is not. (And as yields rise, bond prices fall.) The Federal Reserve’s stated intention is to push inflation above its previous 2% target, meaning negative real returns.
All of which argue that Treasury inflation-protected securities, or TIPS, would provide a better hedge to the equity portfolio. Therefore, gold, inflation and bond yields should increase from their historical lows. Short-term fixed-income investments can add a measure of stability to a diversified portfolio. Currently their yields are low, but they bear less risk when yields increase.
JPMorgan strategist Jan Loyes offers another option for a 60/40 portfolio for a world of zero-interest rates: Mix in “equity-like bonds and bond-like equities,” Such as convertible securities, high-yield bonds, and shares of real-estate investment trusts– Surveys that do not fit most standard benchmarks, such as the S&P 500 and the Bloomberg Barclays Egg Bonding Index.
Over the last 40 to 50 years, the 60/40 standard portfolio has performed brilliantly. From 1983 to 2010, it returned 9.9% year-over-year, with 11.2% annualized returns from the S&P and 7.0% from the Ag, both reducing interest rate declines from historic highs to historic lows.
Looking ahead is predictable, but there is a certainty: the returns will be lower. There may be “Japanisation” of the bond market, with yields nearing zero for many years. Alternatively, the future may see rising inflation and higher yields from the Fed’s massive bond purchases, which effectively “monetizes” the Treasury’s multi-trillion-dollar budget deficit. All of this is unknown, so the working assumption is that the current 1.3% yield will constitute annual returns from bonds for the next decade, Loyce wrote in a customer note.
Future returns of stocks are even more unlikely. Left to various dense analyzes, JPMorgan’s assumption for the next 10 years is that they will return 5% annually.
According to Loyce’s estimate, the 60/40 portfolio together is projected to return 3.5% per year over the next decade. This would be far less than the needs of many institutions such as pension funds and endowments. For a person, after taxes, that return would hardly be ahead of inflation, if that.
Adding suggested alternative investments can significantly increase returns. Since 1987, a “hybrid” is equally weighted in high-yield bonds, convertibles, REITs and utilities, which have returned 10% year-on-year against the S&P 500’s 11%.
Moving forward for the next 10 years, a mix of 20% conventional bonds, 40% hybrids and 40% stocks will provide an estimated annual return of around 4%, the bank’s simulation shows. It should be emphasized that the annual volatility of hybrids can be almost as high as stocks’ (as the capital market downturn demonstrated dramatically during March), but it is significantly lower in a decade.
This would be a theoretical practice for individual investors before the era of all exchange-traded funds. But today, hybrid buckets can be filled with ETFs such as
iShares iBoxx $ High Yield Corporate Bond
SPDR Bloomberg Barclays Convertible Securities
(CWB), the Vanguard Real Estate Index (VNQ), and
Choose Utilities Sector SPDR
(XLU), to cite the largest name in each region.
The message is that investors should hold fewer “safe” bonds and equal allocations for these hybrids and equities in a conservative portfolio. Further shifting to a 60% hybrid / 40% stock will provide an estimated 5% return over the next decade as an all-equity return with very little volatility by the end of the period, Loeys estimates. In addition, he says in another note, apart from American hybrids, foreign-based investors will also benefit.
To quote the great philosopher Yogi Berra, the future is not what it used to be. The portfolio should adjust accordingly.
Write Randall W. Forsyth at [email protected]