The 60/40 Portfolio Doesn’t Work Anymore

It can be hard to see a bubble when you’re smack-dab in the middle of it. I think that describes our situation today.

Let’s look at a few large tech stocks’ price-to-earnings (P/E) ratios

These valuations are worrying. Yes, these companies have historically shown high growth. But at these kinds of levels, valuations are starting to get ridiculous. 

P/E is a commonly used indicator of how expensive a stock is. You can think of P/E as a multiple of how expensive a company is compared to its earnings. The lower it is, the cheaper a stock generally is. And a higher P/E means it’s more expensive. There are other factors to consider, such as debt, debt load, growth rate, and assets. But P/E is generally a good place to start to figure out how expensive a stock or index is.

Overall, the Nasdaq 100 currently trades at an average P/E ratio of 35.9 according to WSJ data. A year ago it was around 25. Back in 2000, it peaked at a P/E ratio of more than 100, so we’re still far from that level. However, I wouldn’t exactly call current U.S. stock valuations attractive. 

The S&P 500 currently trades at a P/E ratio of around 35. Its historic average is around 13-15, according to Investopedia

When you factor in the record levels of corporate debt and a questionable economic outlook, the outlook for stocks gets even cloudier.

Bonds are Bubbly Too

When stocks are overvalued, one of the best historical strategies has been to switch into high-quality bonds. Bonds tend to do well when stocks are lagging, so it’s been a winning strategy for a long time.

Many investors go with a traditional “60/40” portfolio — 60% in stocks and 40% in bonds. This portfolio structure has worked incredibly well for more than 100 years, returning 8% a year on average since 1861.

But bonds today don’t have the same appeal they once did. Most U.S. government bonds today have real yields — after inflation — of near or even below zero percent. Many high-quality corporate bonds also have real yields at or near zero.

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William K. 4 weeks ago Member's comment

The out-of-sight trice to earnings ratios can be explained as the result of a "stampede", based on euphoria. The stock market has always had an emotional ingredient and now is no exception. That is part of the reasons why it is a challenge to predict accurately and consistently. Raging emotions among the unstable are very difficult to predict.