Where’s the Value in That?

The Price You Pay vs. the Value You Get Is Everything in Investing

Even the safest investment on the planet can turn into a disaster if there is not enough value behind the price you pay. Morningstar recently published an article evaluating the 60/40 portfolio’s success for the last 150 years, until 2022 arrived.

The 60/40 portfolio refers to an account that consists of 60% stocks and 40% bonds. Historically, the money invested in bonds has always moderated some of the volatility that comes from stocks. Morningstar illustrates several significant market declines and the benefits of the 60/40 portfolio.

• During the 1929 crash and the following depression, stocks fell by a total of 79%, while the 60/40 portfolio only declined by 52%.
• In the 70s, stocks declined 52% vs. a 39% decline for a 60/40 mix.
• In the early 2000s, the 60/40 portfolio only lost half the value that occurred in stocks.
• In March 2020, during the COVID crash, the 60/40 portfolio was down 8% at its worst, while the S&P 500 fell by more than 30%.

For the last 100 years, the 60/40 portfolio has been a great alternative to being fully invested in stocks, providing most of the market’s return with less volatility. Then came 2022.

Safety Isn’t Always Cheap

When the 10-year Treasury note was yielding less than 1%, you had to wonder: how much value was there? If interest rates rise—which they eventually did—the outcome is not pretty. Just because something has worked doesn’t mean it will work in the future.

If you were the unlucky investor who bought a $1,000 treasury note in 2021 yielding 1%, you’re stuck collecting a grand total of $10 per year for the next ten years. Since interest rates are now about 4%, or $40 per $1,000, your bond is worth considerably less. Even four years later, you are still sitting on a loss, and it will almost take until 2031 to get back to even. This is why the “conservative” 60/40 portfolio has yet to recover from its 2022 losses (the Vanguard 60/40 fund, VBIAX, is up 1% considering price only and 19% total return since November 2021). Meanwhile, the stock market has almost doubled from its low experienced in 2022.

Is the 60/40 portfolio still appropriate for retirees?

You don’t need a degree in finance to realize it all depends on where you start. Buying bonds today at 4% is completely different than buying them at 1%. If they decline in value due to higher interest rates, it is common sense that it takes much less time to recover a loss if you are earning a higher yield. The 60/40 portfolio is more attractive today than three years ago when interest rates were much lower. There is much more value in the 40% you invest in bonds today.

When Everyone’s In, Who’s Left to Buy?

This leads us to what is shaping up to be the next asset class that appears to have lost sight of any value.

Even Jamie Dimon at JPMorgan Chase, who is arguably the best bank CEO in the country, can’t resist the fees of private credit. The bank is reportedly investing $50 billion in private credit, even though Dimon recently warned it is a recipe for the next financial crisis.

Private credit refers to loans made to mid-sized companies that fall outside the normal bank lending channels. Many of these loans are packaged in funds and sold to investors who love the 10% plus yields. Since default rates have been hovering around all-time lows, this 10% seems like a no-brainer. Everybody seems to agree. It is estimated that the current private credit market is $2.5 trillion, up from $1.2 trillion in 2020. Everybody wants in.

The problem is simple: just because default rates have been low for speculative credit bonds doesn’t mean they will stay low. Over the last decade, BB-rated bond default rates have stayed below 1%. This has led most investors to think they are reasonably safe, not to mention that earning 10% will cover some losses over time. However, in a recession, it can turn ugly fast. In 2020, one private credit fund fell from $16 to $7 in just one month. When panic strikes, investors sell first and ask questions later.

The private credit market seems to be comparable to Treasury yields in 2021—they appeared safe but lacked any real value. At 1%, Treasuries turned out to be anything but safe. At 10%, does private credit offer any value today? It doesn’t seem like it.

Observations On The Market No. 409