Tactical Asset Allocation — Long Live the 60/40

Additional content provided by John Lohse, Senior Analyst, Research

Much has been discussed regarding the 60/40 stock/bond portfolio recently. While it came under immense pressure in 2022, 2023 saw a resurgence of cornerstone asset allocation. LPL Research believes the 60/40 still more than holds its ground as a valuable tool in portfolio construction. Especially as interest rates normalize, and equity markets navigate potential economic slowdowns. Therefore, we believed it would be fitting to review the LPL Research Tactical Asset Allocation’s (TAA) 60/40 strategy, which aligns with our Growth with Income (GwI) Investment Objective (IO). We also examine one of our model portfolios, the Model Wealth Portfolio (MWP) Tactical Exchange Traded Products (ETP) model, that LPL clients can use to implement these views. 

Equities

The GwI (60/40) TAA currently has an overall neutral view on equities, holding 60% stocks versus a benchmark of 60% stocks, 35% fixed income, and 5% cash. LPL Research’s Strategic and Tactical Asset Allocation Committee’s (STAAC) year-end fair value target (calculated using our estimates for earnings and market multiples) for the S&P 500 is right around current levels, indicating the belief that the risk-reward balance between stocks and bonds is relatively balanced at present, despite strong year-to-date gains given the improved economic backdrop. 

On geographic equity exposures, the TAA favors an above-benchmark exposure to U.S. equities funded by an underweight to emerging markets. Within domestic equities there is an up-market-cap bias (although small cap value has become increasingly attractive) favoring large cap equities and within large caps favoring growth over value.  Large cap growth is the current largest equity overweight based on favorable views on strong large cap balance sheets, and growth tailwinds including interest rate stability, solid fundamental footing, and momentum in technology-oriented names. 

Outside of the TAA, the STAAC also has a favorable view on two equity sectors — communication services and energy. Communication services had a strong Q4 earnings season, a positive technical backdrop, and the advantageous positioning of digital media companies. The energy sector has seen improved profitability and attractive valuations.  The STAAC is underweight in the consumer staples and real estate sectors, favoring cyclical over defensive sectors overall. 

Fixed Income 

Treasury yields were higher in January as interest rate cuts got priced out to the May Federal Reserve (Fed) meeting, at the earliest, due to the still resilient economy. The market got ahead of itself late last year in pricing in aggressive rate cuts, so a back-up in yields has been warranted, in our opinion. Still, starting yields for many fixed income markets are at levels last seen over a decade ago, so the return prospects for fixed income remain favorable, in our view. The TAA has been overweight bonds by 3% versus its benchmark since June of last year, funding this with an underweight to cash. 

Within bond sectors, the STAAC favors mortgage-backed securities (MBS) and preferred securities over corporate bonds. MBS spreads (the difference in rates between the asset and a Treasury security of the same maturity) are at multi-year highs, while corporate credit spreads, particularly in lower-rated debt, are very tight. Preferred securities saw a sharp decline following last March’s sell-off in the banking sector. This provided an attractive entry point to buy, as the TAA launched a position in Q1 2023. 

The chart below reflects the tactical asset allocation and benchmark weights in the GwI 60/40. 

LPL Research Growth with Income (60/40) Tactical Asset Allocation

Source: LPL Research 02/16/24

Summary 

We believe the demise of the 60/40 was greatly exaggerated, and it is still an important portfolio construction tool into 2024 and beyond. This investment environment, as with most, is fast-moving and comes with its challenges, however, those challenges bring opportunity, and the 60/40 (GwI IO) Tactical Asset Allocation lends itself to capturing those opportunities in both the equity and fixed income markets.   

How to Implement in Model Portfolios

The LPL Research model portfolio that captures our TAA and equity sector views most closely is the MWP Tactical Exchange Traded Product (ETP) model. This model has over $2.9 billion in assets as of January 31, 2024, with over $1 billion in the GwI (60/40) IO and has an almost 15-year track record, following its inception in July 2009.  The model’s investment approach is designed to adapt to changing market conditions, with a time horizon of 3–12 months, and it typically executes 5 to 10 trades per year. The model follows the TAA guidance provided by the STAAC, using mostly passive, cost-efficient ETPs to implement those views, as well as implementing sector views with sector-specific exchange-traded funds (ETFs).