Reverse look at the 60/40 model

The reference model suggesting an asset allocation of “60% stocks and 40% bonds” has regained some relevance with the rise in yields on fixed income securities and the expected decline in interest rates. More analysts have pushed further and tended towards a reversal of this distribution.

During a round table of experts held in mid-October, Martin Lefebvre, strategist and head of investments at the National Bank, emphasized that bonds can now be considered “a great alternative”, presenting “less risk” . There was a transfer of risk from bonds to equities due to low interest rates. But today, and with this inverse relationship between interest rate and bond price, “without really taking any risks, you can have 6% which will develop into 7%, 8%, 9%, even 10% with the additional capital gain, if we think that rates will fall,” according to comments collected by colleague Clémence Pavic. As for the stock market, correction phases could be dominant and the expert pleads for a “cautionary scenario”.

In a video clip presented at the beginning of October, Daniel Ouellet, portfolio manager at the Ouellet Bolduc Group, at Desjardins Wealth Management, calculates that it should cost less to be precisely prudent in 2024. By reversing the price/earnings ratio of the American S&P 500 index, we currently observe that corporate profits provide the investor with the equivalent of a return of 5.25%. When compared to the 10-year US Treasury rate of 4.75%, the equity market’s risk premium over the bond market is 50 basis points, he says. “You have to go back 20 years to find such a low risk premium. » Which encourages increased positioning of portfolios in bond securities.

In other words, the average difference of four percentage points that favored a growth portfolio compared to a balanced portfolio over the last ten years is expected to be reduced, says the specialist. Added to this context is a correction in stock prices making it possible to obtain top quality company shares at low prices, with a higher dividend rate.

The scenario of an increased weight of bonds within portfolios is thus reinforced in this inflationary situation and this potential for a recession which, if it manifests itself, would lead to both a drop in long-term interest rates term and increased volatility in the stock market. With, as a result, geopolitical crises becoming the main global risk, according to market participants, surpassing that of global warming.

And in all this, what about guaranteed investment certificates offered at rates higher than 5%? “Indeed, it’s been a long time since we’ve seen that. But the rate is fixed and the capital is frozen until maturity. The marketable bond offers just as much yield, but its advantage is liquidity. It also allows a mix of taxation in a context of falling interest rates. But I am not against the CPG if the investor wants certainty,” emphasized Daniel Ouellet in an interview with Duty granted last November.

Forecast 2024

For information purposes, let’s look at the forecasts from Desjardins Group economists. In the United States, Wall Street’s benchmark index, the S&P 500, is expected to end 2024 around 4,300 points, representing growth of 5% over one year. In Toronto, the S&P/TSX could do better and end the year around 20,000, with an 8% increase.

On the government bond scene. the rate on the 30-year US Treasury note is expected at 3.4% at the end of next year, compared to 4.6% this year. That on the Government of Canada bond with a 5-year maturity is seen at 2.65%, compared to 4.1% at the end of 2023. As for the famous yield curve, currently inverted and therefore a harbinger of a recession, it seems he says, it should flatten out with rates oscillating between 3.3 and 3.45% for maturities of 2 years and 30 years respectively in the United States, and between 2.7 and 2.75% for this side of the border.

The institution’s economists also foresee the beginning of a decline in the key rate of central banks from the second quarter in Canada, and the third in the United States.

Healthy retirement plans

Pension plans are also benefiting from soaring interest rates. A balanced pension-style portfolio would have produced a return of –4.9% in the third quarter, compared to a positive return of 2.1% in the second and 4.6% in the first. However, despite this negative performance, the Mercer Pension Financial Health Index, which measures the median solvency of defined benefit (DB) pension plans in its database, increased from 119% to June 30, 2023 at 125% as of September 30. This is due to the more than offsetting effect of rising interest rates on the value of liabilities. The index was at 113% at the start of the year.

At the end of the third quarter, it is estimated that 88% of plans in the database have surplus assets based on the solvency approach (compared to 85% at the end of the second). In Canada, many DB plans are in surplus. “Many of them have reached a level of capitalization making contribution holidays possible (which has not happened for a while),” Mercer points out.

Interesting !

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