Long-bond revolt pressures 60/40 comeback in chaotic market
The strategy is performing as advertised even amid violent swings in both stocks and bonds
A SLUMP in US long-dated bonds is clouding the comeback of a classic investment strategy.
The so-called 60/40 portfolio – long recommended for investors who want to balance exposure to risk with a cushion of safer, steady income – calls for allocating 60 per cent of holdings to stocks and 40 per cent to bonds. While a bedrock for retirement savers over decades, the approach lost some of its lustre in recent years as its underlying mechanism fell out of whack, with US stocks and bonds moving more in lockstep rather than offsetting each other.
This year, the strategy has come back into its own, performing as advertised even amid violent swings in both stocks and bonds. A US gauge of the 60/40 mode returned some 1.6 per cent this year through mid-May, besting the S&P 500 index’s return in the period, and with lower volatility, according to data compiled by Bloomberg.
A key part of the revival has been the return of the traditional inverse relationship between stocks and bonds. The correlation between US equities and fixed income over the past six months has reached the most negative level since 2021, meaning bonds tend to rise when stocks fall, and vice versa.
“A balanced approach does make sense in the longer term,” said Jeff Given, a senior portfolio manager at Manulife Investment Management.
One recent major development has cropped up, though, to threaten that balance.
BT in your inbox
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
Benchmark 30-year Treasury bonds have tumbled this month, sending yields above 5 per cent towards the highest in almost two decades, as investors grew increasingly wary of holding long-term US sovereign securities amid spiralling debt and deficits.
The selling increased last week as Republican lawmakers haggled over US President Donald Trump’s signature tax-cut Bill that would add trillions of dollars to already bulging Budget gaps. Moody’s Ratings stripped the US of its top credit rating this month, citing deficit concerns.
Rising long-term US yields – along with those in Japan and the UK – spilled over across financial markets as equities declined along with the US dollar. The simultaneous sell-off of US assets was reminiscent of what happened earlier in April, when Trump’s aggressive “Liberation Day” trade policies roiled global markets and doubts about US bonds’ status as a haven started creeping in.
“What you are seeing in the back end of the curve globally is that they are behaving like risk assets, not like the typical kind of defensive risk-averse assets,” Greg Peters, co-chief investment officer at PGIM Fixed Income, said on Bloomberg Television.
Treasury Secretary Scott Bessent said on Friday (May 23) on Bloomberg Television’s Wall Street Week with David Westin that he was not concerned about the recent rise in long-term yields. He added that recent Treasury data he had seen showed foreign accounts stepping up purchases at the latest US debt auctions.
As investors perceive more risk in long-term Treasuries, that poses a challenge to the 60/40 construction. But more broadly, the rationale still holds.
For Andrzej Skiba, head of BlueBay US fixed income at RBC Global Asset Management, it may be more a case of the model being bent but not broken. The key is to pick the right bonds along the yield curve.
While long-term bonds are pressured as investors demand higher yields to compensate for the deficit risks, shorter-term notes are holding up better, he said. That is because any economic slowdown would allow the Federal Reserve to lower interest rates, benefiting those securities as they are more sensitive to monetary policy and less vulnerable to fiscal concerns.
“I would not lose faith entirely in the ability of Treasuries or fixed-income securities to protect your returns,” Skiba said. “While there is a lot of the concern that deficits impact bond valuations further out the curve, we do think that the front end is likely to behave as investors would expect, were slowdown fears to spike again.”
The data bears out this view, with shorter-maturity bonds outperforming longer-dated securities year to date, a phenomenon known in Wall Street parlance as curve steepening.
Even as 30-year yields have climbed by about a quarter percentage point this year, both two-year and five-year yields have dropped by nearly the same amount, as investors favoured shorter-term debt and shunned the long end. The so-called steepener trade has become a favourite strategy among bond investors to play the theme of slower growth, and higher inflation and deficits.
The outperformance of shorter to medium-term bonds also explains why the benchmark US bond index – which has similar interest rate risks to that part of the curve – remains negatively correlated to stocks. The average duration of the Bloomberg Treasury Index, a measure of interest rate risk, is about 5.7, less than half that of 30-year debt.
Overall, Treasuries have lost almost 1.8 per cent so far in May, but are still up just over 1.7 per cent for the year after four months of steady returns. By contrast, the S&P 500 surged more than 4 per cent in May, but only after three straight months of declines that at one point took the index to the brink of a bear market. The gauge remains down year to date.
“Being broadly diversified in fixed income has worked, and it will continue to work,” Meera Pandit, global market strategist at JPMorgan Asset Management, said on Bloomberg Television.
Treasury 10-year note futures declined 7/32 to 109 7/8 in Asian trading on Monday, equivalent to a rise of about three basis points in yield. Cash trading of US government bonds is shut globally for a holiday.
Fuelled by positive signals on trade deals and solid tech earnings, the recovery of stocks has pushed S&P 500 valuations near historical highs. The earnings yield of the S&P 500, which measures how much investors are willing to pay for each US dollar of corporate profit, has dropped to 3.95 per cent, about half a percentage point below 10-year yields.
The current valuation points to long-term stock returns of around 6 to 7 per cent, not particularly attractive when compared with the average yield of about 4.8 per cent in the Bloomberg Aggregate Bond Index, according to Manulife’s Given.
As for bonds, Given said he favours the so-called belly of the US yield curve, such as five-year notes, over longer-term bonds because of the risks around rising debt levels.
“I do think that belly may be a better risk hedge than 30-year Treasuries,” he said.
Sameer Samana, head of equities and real assets at Wells Fargo Investment Institute, agreed.
“The S&P’s resilience in the face of the deteriorating macro and fundamental background is an opportunity for investors to rebalance towards cash and bonds,” Samana said. “However, we would not go too far out on the curve.”
Copyright SPH Media. All rights reserved.
