Three Key Catalysts for the 60/40 Strategy
History suggests this traditional mix of stocks and bonds could rebound in 2023.
Commentary
The traditional investment mix of 60% stocks and 40% bonds, which for decades
has tended to appeal to investors with a moderate risk tolerance, posted a double-
digit negative return in 2022, its worst year since 2008 (global financial crisis), and
one of its worst in nearly a century.
Three Key Catalysts for the 60/40
Strategy
History suggests this traditional mix of stocks and bonds
could rebound in 2023.
Denise Chisholm
Director of Quantitative
Market Strategy
I approach my research by looking at market data through a historian’s
lens. I believe historical patterns, when considered in the appropriate
context, can help investors build conviction about future trends. This
month, I’m focusing on the possibility that bonds could post a positive
return in 2023 and perhaps even beat the stock market.
EXHIBIT 1:
Historical 60/40 Index Results
Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss.
It is not possible to invest directly in an index. Fidelity proprietary analysis using historical index returns.
Domestic Equity—S&P 500
®
Index; Bonds—Bloomberg U.S. Long Treasury Index. Source: Fidelity Investments
(AART), and Haver Analytics, as of 12/31/22.
40%
1926
1942
1958
1974
1990
2006
2022
-20%
20%
0%
-40%
Three Key Catalysts for the 60/40 Strategy
|
2
Past performance is no guarantee of future results. Diversification does not
ensure a profit or guarantee against a loss. It is not possible to invest directly
in an index. Fidelity proprietary analysis using historical index returns from
1926 through 2022. Domestic Equity—S&P 500 Index; Long Treasuries—
Bloomberg U.S. Long Treasury Index. Source: Fidelity Investments (AART)
and Haver Analytics, as of 12/31/22.
EXHIBIT 2:
Historical Odds of a Positive Performance Year
The main benefit of owning a 60/40 blend of stocks
and bonds has been that, in the past, bond gains
have often diminished losses in down years for stocks
(bonds have often risen in years when stock returns
declined). This didn’t happen last year, however, as
each asset class posted a rare double-digit decline.
Could the outlook for a 60/40 approach look better
for 2023?
Some market research suggests that longer term, real
returns (adjusted for inflation) could be lower for both
stocks and bonds, thus requiring an expanded list of
asset classes to be diversified. That said, the 60/40 mix
has cushioned against large stock market drawdowns
frequently in the past, and there are several reasons to
believe that 60/40 could rebound this year.
Understanding what went wrong for 60/40
in 2022
Before we discuss what could go right for 60/40, it’s
important to understand what happened last year. As
Exhibit 1 shows, 2022 marked a rare year for the 60/40
stock vs. bond blend, which suffered only its fifth
double-digit decline since 1926. Reasons behind this
poor showing included a volatile period marked by
persistently high inflation exacerbated by the Russia—
Ukraine conflict, reduced consumer confidence, and
growing recessionary risks.
Bonds historically have helped to protect against stock
declines, driven by investors who sought relatively
less-volatile assets in times of market distress. In 2022,
however, one of the U.S. Federal Reserve’s most
aggressive rate-tightening campaigns in history helped
reduce the value of bonds. To make matters worse,
historically low starting yields didn’t offer much of a
performance offset when bond prices declined.
Looking at the longer-term track record for
60/40
Investors who worry that 2022 could be repeated
might be comforted by a longer-term historical view.
Over time, the 60/40 has arguably done what it was
designed to do. For example, since 1926, the odds of a
positive year for the S&P 500 index and the Bloomberg
U.S. Long Treasury Index each stood at 73%, whereas a
hypothetical no-fee 60/40 portfolio composed of each
of these indexes managed a positive return at a slightly
higher 78% rate due to the contributions of bonds in
down years for equities (Exhibit 2).
0%
20%
40%
60%
80%
Equities
73%
73%
78%
Bonds
60/40
Three Key Catalysts for the 60/40 Strategy
|
3
Past performance is no guarantee of future results. Diversification does not
ensure a profit or guarantee against a loss. It is not possible to invest directly
in an index. Fidelity proprietary analysis using historical index returns from
1926 through 2022. Domestic Equity—S&P 500 Index; Long Treasuries—
Bloomberg U.S. Long Treasury Index. A higher Sharpe ratio indicates a
higher risk-adjusted return. Source: Fidelity Investments (AART) and Haver
Analytics, as of 12/31/22.
EXHIBIT 3:
A Historical Comparison of Risk-Adjusted Returns
The long-term performance story for 60/40 hasn’t been
so much its historical percentage of annual upside:
it’s been about risk-adjusted returns. Since 1926, the
Sharpe ratio
1
, which calculates the return for each
unit of risk, has been higher for a 60/40 blend than
owning either stocks or investment-grade bonds alone
(Exhibit 3). This higher Sharpe ratio suggests 60/40 has
delivered relatively better compensation for the risk
taken than investing just in stocks.
Looking ahead for 60/40
Could 60/40 return to its historical role of producing
better risk-adjusted returns than stocks while helping
to buffer against equity risks?
The answer will be influenced by the performance for
the stock and bond markets individually this year, and
perhaps by some historical factors regarding 60/40
performance. After analyzing each, I see three key
reasons the 60/40 allocation could improve upon its
poor result in 2022:
1: Stocks could do OK in 2023
The strong start for equities early this year may be
partly influenced by a trend I’ve been watching
closely—stocks that have been moving in closer
concert with each other.
Climbing a wall of worry about the economy, the S&P
500 gained more than 6% in January. Fundamental
and macro analysts likely will point to drivers including
continued signals of cooling inflation, expectations
for a slowdown in the Fed’s pace of rate hikes, and a
rebound for certain large-cap technology stocks.
A less-followed trend behind the market optimism may
be the recent increase in stock correlations (individual
stock movements relative to each other), which has
been a positive signal for market performance in the
past. Stock correlations reached their top decile in
October 2022 (Exhibit 4).
0.00
0.20
0.40
0.60
0.80
Equities
0.60
0.54
0.73
Bonds
60/40
EXHIBIT 4:
Stocks have tended to thrive after high correlations.
Equity Market Correlation and S&P 500 NTM Returns,
1994–Present
Past performance is no guarantee of future results. NTM: Next twelve months.
Analysis based on the S&P 500. All data gathered and analyzed monthly.
Sources: Haver Analytics and Fidelity Investments, as of 10/31/22.
–4
0%
–2
0%
0%
20%
40%
60%
10%
Quartile 1
—
Low C
orre
lations
6%
Q2
8%
Q3
14%
Q4
23%
Top Decile
—
High C
orre
lations
Av
era ge
–30
%
–10
%
10
%
30
%
50
%
–50
%
Three Key Catalysts for the 60/40 Strategy
|
4
Notably, the stock market posted an average return of 23% in the 12 months after
the past 25 instances. It’s one suggestion that the stock market could increase
further, even if we see volatility at some point.
2: Bonds may do better than stocks
If equity correlations were to break down and stocks were to manage only a paltry
gain or decline in 2023, bonds may outperform stocks for the year. One reason for
bond-market optimism is that, as of the start of 2023, bonds offered their highest
yields in more than a decade. These higher yields can help to hedge against the
potential for increased spread volatility.
Late in 2022, the yield on two-year U.S. Treasuries (about 4%) surpassed the yield of
the average utility stock in the S&P 500 index for the first time since 2007. Since 1990,
the higher short-term bond yields have been compared with utilities, the more likely
longer-term bonds have been to outperform stocks over the next 12 months (Exhibit 5).
The potential for market yields peaking in 2023 may be another encouraging sign for
bond-market returns. Following the past five peaks for market yields, dating back
to 2000, U.S. corporate bonds, U.S. credit, and U.S. high-yield bonds all averaged
double-digit returns in the next three-and five-year periods.
2
Moreover, lower inflation could make it more likely that the Fed will ease or even end
its cycle of higher policy rates at some point this year. Based on the fed funds rate
as of January 25, participants in the futures market anticipate that the Fed will end
its cycle of higher policy rates at some point by midyear, which could contribute to
higher long-term bond prices.
3
EXHIBIT 5:
Bonds have outperformed after their yields exceed those of utilities.
Average NTM Long-Dated Treasury Total Return versus S&P 500® Total Return after Two-Year
Treasury Yields Surpass Yields for Utilities Stocks
Past performance is no guarantee of future results. Analysis based on the S&P 500 and the Bloomberg U.S. Long
Treasuries Index since 1990. The yield comparison is based on the two-year US Treasury yield versus the median yield
of utilities stocks in the S&P 500 index since 1990, measured monthly. NTM: Next twelve months. Sources: Haver
Analytics and Fidelity Investments, as of 10/31/22.
–1
1%
–1
%
2%
7%
–1
5%
–1
0%
–5
%
0%
5%
10%
Lowest Quart ile
(Lower Treasury Relative Yield)
Q2
Q3
Highest Quart ile
(Highest Treasury Relative Yield)
Three Key Catalysts for the 60/40 Strategy
|
5
3: The valuations and the rebound history for
60/40
Looking at the historical performance of a 60/40
allocation of stocks and bonds in past cycles may
provide some clues as to whether the 60/40 mix could
rebound as well.
After a down year for 60/40 performance since
1926, the odds of this ratio of the S&P 500 index and
investment-grade credit posting a positive return (75%)
in the following 12 months roughly matched the odds
of a positive return in all years (78%).
That said, in the modern era (since 1962), which
eliminates two outlier years during the Great
Depression, the same 60/40 mix produced a positive
return in 85% of years following a down year (Exhibit 6).
Stock valuations also have played a role in the
historical performance of 60/40.
Since 1926, a 60/40 mix of the S&P 500 index and
investment-grade credit had 71% odds of a positive
12-month return when stock valuations traded at
greater 20 times earnings, and an average gain of 5.2%
(Exhibit 7).
Both the odds of a positive 12-month return (80%) and
the average returns (10.8%) increased meaningfully
when starting valuations were less than or equal to 20
times earnings, which was the case at the start of 2023.
Conclusion:
Stock volatility is still possible and may even be likely
at some point this year. That said, there are signs for
stock market optimism, partly due to correlations and
starting valuations. If this doesn’t materialize, bonds—
due to their higher yields than the start of 2022—could
revert to their historical role and help cushion the blow
of a stock-market drawdown in a 60/40 mix.
Past performance is no guarantee of future results. Diversification does not
ensure a profit or guarantee against a loss. It is not possible to invest directly
in an index. Fidelity proprietary analysis using historical index returns from
1926 through 2022. Domestic Equity—S&P 500 Index; Long Treasuries—
Bloomberg U.S. Long Treasury Index. NTM: Next 12 months. Source:
Fidelity Investments Asset Allocation Research Team (AART) and Haver
Analytics, as of 12/31/22.
Past performance is no guarantee of future results. Diversification does not
ensure a profit or guarantee against a loss. It is not possible to invest directly
in an index. Fidelity proprietary analysis using historical index returns from
1926 through 2022. Domestic Equity—S&P 500 Index; Long Treasuries—
Bloomberg U.S. Long Treasury Index. “Odds” referenced in the exhibit
refers to the historical odds of a positive 12-month return. Starting valuations
measured and analyzed monthly. Source: Fidelity Investments (AART) and
Haver Analytics, as of 12/31/22.
EXHIBIT 6:
60/40 Historical Odds of Positive Performance
NTM Following a Down Year (for 60/40)
EXHIBIT 7:
Average Annual 60/40 Returns Based on Starting
Stock Valuations
0
20%
40%
60%
80%
100%
60/40
78%
75%
85%
After a
Down Year
After a Down
Year Since 1962
0%
2%
4%
6%
8%
10%
12%
5.2%
(71% Odds)
10.8%
(80% Odds)
Starting Point > 20x
Price/Earnings
Starting Point < 20x
Price/Earnings
Endnote:
1.
The Sharpe ratio divides a portfolio’s excess return (what it earns above a risk-free rete that
often approximated using U.S. Treasuries) by the standard deviation of returns over the same
time frame. When comparing similar portfolios, a higher Sharpe ratio indicates a higher risk-
adjusted return.
2.
Source: Bloomberg Finance L.P., most recent data collected as of 12/31/22.
Index returns calculated using monthly data. US Credit returns calculated using the Bloomberg
US Credit Total Return Value Unhedged USD Index. US Corporate Bonds calculated using the
Bloomberg US Corporate Total Return Value Unhedged USD Index. US High Yield calculated
using the Bloomberg US Corporate HY Total Return Value Unhedged USD Index.
3.
Implied fed
funds rate calculated by Bloomberg Finance L.P., as of 1/25/23, peaking in June 2023 at 4.914%,
then declining for the remainder of the year.
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Past performance is no guarantee of future results. • Investing involves risk, including risk of loss.
Diversification and asset allocation do not ensure a profit or guarantee against loss.
All indexes are unmanaged. You cannot invest directly in an index. Index or benchmark
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Index Definitions:
The S&P 500
®
index
is a market capitalization-weighted index of 500 common stocks chosen
for market size, liquidity, and industry group representation to represent U.S. equity performance.
S&P 500 is a registered service mark of Standard & Poor’s Financial Services LLC. Sectors and
industries are defined by the Global Industry Classification Standard (GICS).
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Treasury Index
is a market value-weighted index of investment-grade fixed-rate public obligations
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Author
Denise Chisholm
Director of Quantitative Market Strategy
Denise Chisholm is a market strategist in the
Quantitative Research and Investments (QRI)
division at Fidelity Investments. In this role, she
is focused on historical analysis, its application
in diversified portfolio strategies, and ways
to combine investment building blocks, such
as factors, sectors, and themes. In addition to
her research responsibilities, Ms. Chisholm is
a popular contributor at various Fidelity client
forums, is a LinkedIn 2020 Top Voice, and
frequently appears in the media.
Prior to assuming her current responsibilities in
September 2020, Ms. Chisholm held multiple
roles within Fidelity, including sector strategist,
research analyst on the Megacap Research team,
research analyst on the International team, and
sector specialist.
Fidelity Thought Leadership Vice President Mike
Tarsala provided editorial direction for this article.
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