It's Time to Alter 'Set It, Forget It' Portfolio Strategies.

"An earlier generation had an experience similar to ours today. In the mid-1960s, stock valuations were at their most expensive level in decades based on a cyclically adjusted formula devised by Nobel Prize-winning economist Robert Shiller. And stocks were pricey just as inflation began to take off.

The result: A family setting aside $1,000 for their toddler's education at the end of 1965 in a 60/40 portfolio ended up with $785 in real terms by her senior year of high school in January 1982.

Things aren't looking much better today. Last year was one of the worst ever in real terms for a 60/40 portfolio, and the beatings could continue. Shiller's valuation metric is still higher than it was in 1966.

When stocks have been in the most-expensive quintile of valuations, as they are now, they have produced real annual returns over the following decade of just 2.7% on average. So investors could feel even more pain.

Bonds, the yin to stocks' yang in a balanced portfolio, are the real wild card. Even after their recent slump, investors are concerned the huge pile of federal debt combined with rapidly rising rates could produce financing strains for the U.S. government. The interest bill alone is likely to cross a once-unthinkable trillion dollars annually in a few years -- more than all nondefense discretionary spending.

How high might rates have to rise to keep attracting enough of the world's savings? 

One unnerving possibility is that the Fed could reverse course and push rates down again if today's high rates cause a recession or a stock-market meltdown. That could stoke 1970s-style inflation, or worse.

Investors can prepare by lowering their return expectations and playing defense. Regularly rebalancing a mix of safer and riskier assets still trumps market-timing, though perhaps not with the same assets. With much less volatile short-term Treasury bills yielding more than long-term bonds at the moment, investors can snag a decent return without being blindsided by a further jump in rates.

Ironically, the traditionally risky part of the 60/40 portfolio could be safer, relatively speaking.

Stocks cratered in the inflationary 1970s, but they are more resilient to inflation than bonds. 

Investors also don't have to just buy the pricey S&P 500, which is dominated by the Magnificent Seven tech stocks. 

Small-capitalization, emerging-market and value stocks offer the benefit of diversification at what seems like much cheaper prices.

The next decade might not be pretty, but with work it can be less ugly." [1]

 

1. It's Time to Alter 'Set It, Forget It' Portfolio Strategies. Jakab, Spencer. Wall Street Journal, Eastern edition; New York, N.Y.. 26 Oct 2023: B.1.