Authored by Michael Lebowitz via RealInvestmentAdvice.com,
Most investors, knowingly or not, rely on long-only, passive strategies. They may shift holdings between stocks, bonds, and cash at various intervals, but generally, their portfolio returns mimic those of well-known stock and bond indices.
A recent graph from Goldman Sachs, as shown below, serves as a prescient reminder that this popular portfolio strategy may be worth reconsidering in the current environment.
The graph shows bull and bear market periods based on a portfolio comprised of 60% equities and 40% bonds. This graph uniquely allows the reader to simultaneously visualize both returns and the duration of the respective bullish or bearish periods. Focusing on the current bullish period, here are two important takeaways that investors must consider:
The current bull market in stocks and bonds is 8.7 years old and only about five months shorter than the longest bullish period since at least 1900. That period, the “roaring twenties” preceded the Great Depression.
Total returns for the current recovery are the third highest over the past 118 years, eclipsing both 2008 and 1999, which both resulted in significant (over 50%) drawdowns.
This chart should give investors pause. While it does not necessarily imply the bottom will fall out as it did in the 1930’s, or even 1999 and 2008, it does suggest that asset markets are historically stretched when measured in both return and the duration. Over the coming years, it is highly likely that a sizeable portion of those returns will be lost.
The graph above fails to factor in one consideration that may make the next correction different from the last four. During the last four recessions and related equity market corrections, a balanced portfolio (60/40) benefited greatly from gains in fixed income assets. The graph below compares total returns during those periods of a portfolio that is 100% invested in the S&P 500 versus one that is allocated to the S&P 500 and U.S. 10 year Treasury notes in a 60:40 ratio.
As shown, the addition of bonds and reduction of equities resulted in positive returns during the recessions of 1981 and 1991. During the last two recessions, bonds helped to cut the portfolio’s losses in half.
Looking forward, an important question we must consider is will bonds help minimize losses as they have done in the past. In the prior two recessions, the ten year U.S. Treasury note yields were greater than 4% and nearly double …read more