If the traditional 60/40 portfolio is meant to be a portfolio diversifier, it's not working.
Recent analysis from Bloomberg shows the correlation between the iShares 20+ Year Treasury Bond ETF (TLT) and the SPDR S&P 500 ETF Trust (SPY) hasn't been this high since 2005.
So as bonds sold off last week, stocks followed, leaving nowhere to hide for 60/40 investors, who allocate 60% of their investment to stocks and 40% to bonds to hedge against market downturns.
Truist co-chief investment officer Keith Lerner told Yahoo Finance it's another sign "the traditional playbook is challenged."
Lerner and other strategists that Yahoo Finance spoke with pointed to the Federal Reserve's historically fast rate hiking cycle when explaining why the 60/40 portfolio hasn't been working like it used to.
If things had played out as many expected over the past year, the US would be in a recession by now. Stocks would be down and more investors would likely be in bonds. Instead, a stronger-than-expected economy is reacting better than expected to tight monetarypolicy.
"The economy has been less interest rate sensitive than most people would've thought," Lerner said. "By this time ... If you were raising rates this aggressively you would've thought the economy would've slowed down more meaningfully, which also would've reduced inflation pressures even more and brought down yields on the bond side."
Callie Cox of eToro recently told Yahoo Finance that if there were a clear consensus that a recession is coming, bonds would be catching more bids. But as data continues to come in stronger than expected, what happens next for the economy has become convoluted.
A resilient labor market could continue to support consumer spending while inflation tracks lower, setting the stage for an end toFed rate hikes and a "soft landing" scenario. Or the resilient US economy could stay so strong it reaccelerates inflation and forces the Fed into further rate hikes, likely sending the economy into a recession.
If there were a consensus favorite on those two outcomes, the recent market volatility and increased correlation between bonds and stocks likely wouldn't be present. But that hasn't played out. Even with yields growing increasingly attractive and fears of a "higher for longer" stance from the Fed haunting markets, few investors have fled to safety in bonds.
Strategists don't think that will last forever, though, as the prospects of a 60/40 portfolio, and diversification from stocks, become increasingly attractive.
What's next for 60/40 allocation
Invesco chief global market strategist Kristina Hooper believes the recent rout in both stocks and bonds is a sign investors should be more diversified, bonds included. She suggests something more like a 50/30/20 where the 20% is in alternatives like gold or private credit.
"Alternatives have to be part of that discussion because ... they can often offer that needed lower correlation in difficult times when some major asset classes are closely correlated," Hooper told Yahoo Finance.
Others say the recent moves in the bond market have now forced yields to a level that's made investing in fixed income more attractive.
Learn more about high-yield savings, money market, and CD accounts.
"As we're in a more normal interest rate regime a 60/40 portfolio is finally a bit more compelling than it's been for some time," Interactive Brokers chief strategist and head trader Steve Sosnick told Yahoo Finance. "I get something on the 40 as opposed to just tying money up. Fixed income always has limited appreciation but at least now I'm getting paid for it."
Prior to the post-pandemic spike in yields, 10-year Treasury yields hadn't spent much longer than a month above 3% since 2011. In the past year, those yields have been in a range of 3.2% to nearly 4.9%. Yields on the 10-year and 30-year Treasuries receded slightly during Tuesday's session but are still hovering near recent highs not seen since since 2007.
"The 60/40 is far from dead," Lerner said. "You've had some restoration in those yields now to provide some buffer for the future, even though it's been a painful road to get there. I would say this wouldn't be the time in our view to be giving up on a 60/40 playbook."
"I would say short-term pain. Longer term, I don't want to say gain, but I think longer term the risk-reward improves after such a difficult period."
Correction: A previous version of this article listed an incorrect name for Interactive Brokers' chief strategist. We regret the error.
Josh Schafer is a reporter for Yahoo Finance.
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