So clients relying on their 60/40 (their father’s) allocation could be in for a rude awakening unless advisors help them get their heads around these new market realities. Those who see the problem will, of course, be receptive to appropriate changes in asset allocation. But what changes?
The scenario of increasing correlation and soaring large-cap stocks (i.e., tech) suggests ironically hedging stocks with stocks—using the right value shares hedge growth shares. After all, value stocks would likely benefit from an increase in interest rates, and where could current rates go but up?
Hedging Stock Risk With Stocks
This strategy involves substituting bond holdings with shares of solid value stocks that have steady long-term prices and reliable dividends that are well above bond yields.
An example is 3M (MMM), renowned as a dividend aristocrat, as it has a 62-year record of increasing dividends annually. With a current annual dividend of $5.88 and a dividend yield of 3.6%, the company’s share price ($165 on August 25), has seldom offered a higher yield, as the share price is nearly $100 lower than it was two and a half years ago. In 2007, shares were going for about $100, so 3M’s value has risen despite the Great Recession and the pandemic. Though it’s no juggernaut, 3M is the kind of company that provides investors bond-like stability while paying several times the yield of high-quality corporate bonds.
Another example is Caterpillar (CAT). Though CAT’s share price has moved around more than 3M’s, it has a similar dividend history, rising from $1.84 in 2011 to the current $4.12, with a dividend yield of $2.9%. And the cyclicality endemic to the construction industry would turn beneficial with a Congressional infrastructure package, which has been talked about for years but could actually happen in the next year or two to finally address deteriorating roads, bridges and airports.
Along with current diversification, adding value stocks to portfolios these days might prove a good way to position for near-term price appreciation, as indicated by recent signals of a potential rotation from growth to value. A few months ago, growth-value spreads had begun to narrow, and since then value indexes have risen. For example, over the 13 weeks ended Aug. 21, the S&P 500 value index rose 9.27%. And over the same period, IWS, the iShares Russell Midcap Value Index ETF, had total returns of 13.61%. Should this trend continue, more institution money managers will likely add such shares, making sanguine value projections something of a fait accompli. (Already, some investment houses are recommending that clients lighten up on growth and add value stocks, particularly mid- and small-cap.)
If a rotation to takes hold next year, inflation may increase (much to the chagrin of holders of existing bonds whose values will be depressed by the availability of new issues paying higher yields). This is viewed as a likely scenario for early 2021 by Jeremy Siegel, renowned economist at UPenn’s Wharton School.
Getting clients to authorize substituting stocks for bonds can be difficult after telling them for years that holding bonds was a good idea—like nutritionists discouraging people from eating foods they no longer consider healthful.
But clients expect advisors to tell them what they truly believe, and the more educable among them can be convinced to loosen their grip on 60-40. If they won’t dump all their bonds, perhaps they could part with some of them to guard against the ironic lack of true diversification that their current asset allocations now pose.
Dave Sheaff Gilreath, CFP, is a founding principal of Sheaff Brock Investment Advisors LLC, an equities management firm in Indianapolis.