Thursday, May 19, 2022

The '60/40' Portfolio Is Dead

By Mike Burnick (View Archive)

Editor's note: Over the past several days, we've been sharing insights from our friend and colleague Keith Kaplan, the CEO of our corporate affiliate TradeSmith. Today, we're continuing with an essay from Keith's colleague Mike Burnick, who's a Senior Analyst at TradeSmith.

As Mike explains, the longtime king of portfolio-allocation strategies is failing investors – so it's time to turn elsewhere in today's rising-interest-rate climate...

In monarchy countries, when a new ruler ascends to the throne, it's a tradition to say: 'The king is dead... long live the king!'

After the hammering stock and bond markets have been taking so far this year, it's time to apply that same proclamation to the longtime king of the portfolio-allocation strategies.

I'm talking about the 60/40 split – the long-held allocation strategy that tells investors to put 60% of their holdings in stocks, and the remaining 40% in bonds.

The theory was that stocks and bonds are typically non-correlated asset classes. That's fancy Wall Street-speak for "stocks zig when bonds zag – and vice-versa."

According to Barron's, the 60/40 split has reigned for decades, with an average total return of 9% per year – and with a smoother ride (far less volatility) than you'd experience with an all-stock portfolio.

But with inflation now raging at 40-year highs – and a hawkish U.S. Federal Reserve that's hell-bent on raising interest rates (perhaps significantly) – that allocation has gone from "prudent" to "lethal."

According to a brand-new Bank of America Global Research report, the 60/40 split is on pace to lose 49% on an inflation-adjusted basis this year, which would be the worst showing on record.

The king is dead.

The S&P 500 Index is down about 5% over the past 12 months. But the 30-Year U.S. Treasury Bond Index is down a chest-clutching 13% during that same stretch. In other words, you've lost three times more money in bonds than in stocks.

So much for bonds and their "safe haven" reputation.

The truth is, in a rising-interest-rate climate like the one we're navigating right now, bonds are not 'safe,' nor are they a 'haven'...

A bond pays a fixed interest rate over many years. For the 30-year Treasury bond mentioned above, you are locking in your money with Uncle Sam for the next three decades in return for an interest rate of only 3%.

Compare that with the most recent inflation report where the consumer price index ("CPI") accelerated at an 8.3% annual clip. In other words, once you do the math (and back out the effects of rising prices), your return on that "safe" Treasury bond is a negative 5.3%.

At that rate, you'll most likely go broke over that bond's 30-year lifespan.

It's time to crown a new king...

And that king is stocks – but only the cash-rich, dividend-paying "forever stocks" that my colleague and TradeSmith CEO Keith Kaplan favors in this market – and as "foundational" stocks in any wealth-building portfolio.

Corporate America is in great financial shape today... even better than Uncle Sam, who has gone even deeper in debt in recent years. By contrast, S&P 500 companies have paid it off, with just $1 of debt for every dollar of profits today, compared to $5 of debt for every dollar of profit 10 years ago.

Plus, corporations are flush with cash. They were sitting on a stash of $7.1 trillion in cash at the end of last year, as you can see above.

What will they do with all that cash?

Most likely, they'll use it to pay you.

They'll buy back shares, which will boost the all-important earnings-per-share ("EPS") metric – and will help drive their stock prices higher in the years to come.

And they'll boost their dividends – funneling some of that extra cash flow directly into your pocket.

Analysts expect 13% dividend growth for S&P 500 companies this year, according to Bank of America Global Research. That is more than double the expected EPS growth rate, which is projected to be 6% this year. That expectation for dividend growth is based on precedent. During the 1970s – the last time we experienced inflation this virulent – S&P 500 companies doubled their dividend payouts, too.

The bottom line is that if you want to protect yourself against inflation and higher interest rates, steer clear of most fixed-rate bonds...

Instead, seek out inflation-protected dividend yields from America's high-quality, cash-flow-rich, dividend-paying stocks.

That's where my "safe" money is invested right now.

The king is dead... long live the new king.


Mike Burnick
May 19, 2022

Editor's note: With inflation at 40-year highs, Empire Financial Research CEO Whitney Tilson just went on camera to hold a critical briefing on what to do to prepare for an "inflation shock" that could be coming as soon as next month. Joining him for the special event was Keith Kaplan, who explained a unique way to turn the market's high volatility into more money in your pocket. Watch the replay right here.