The 60/40 stock/bond mix can result in periods of no return

 

Still spending time on the 6/40 stock bond mix. The reason is simple - it is the benchmark for asset allocation. Yes, it works; however, investors should be aware that there are extended periods of flat returns. You can have lost decades of no performance. The challenge is finding alternatives during these flat periods, especially when real yields are negative. Can alternative investments do the trick? The core solution is to find positive real returns with low correlation to equities. Trend-following can do it, but the core returns do not match the periods of lost decades. The challenge is finding the right mix at the right time, with clear rules for triggering a switch in asset allocation.

The changing value of diversiification

 

Hail the 60/40 stock/bond portfolio. It has worked, yet a recent AQR research piece, Diversifying and the Rearview Mirror,  suggests that the value of the 60/40 portfolio will change based on the variable Sharpe ratio of the stock-bond combination. There are times when diversification beyond the 60/40 mix is a drag and other times when it is needed. The average Sharpe ratio for the stock/bond mix is 0.4, so if the Sharpe ratio reaches 1 or falls below -0.5, it is likely to mean-revert. Hence, a selective diversification strategy is valuable. If you feel too good about your 60/40 mix and it feels like diversification is a drag, start diversifying, and if you think the 60/40 mix is proving to be wrong, it is likely to work in your favor. In practice, this is not easy to implement, but it is worth thinking through when to diversify.

Narrative sentiment and attention matters - Read the news!

 

In the paper "The Power of Narrative Attention: Linking Geopolitical and Economic Storylines to Currency Risk and Return Predictability", the authors find that narrative shocks are not fully priced into FX markets and will impact returns over a period of weeks. Even after accounting for major factors, fluctuations in currency markets show time-varying exposure to economic narratives such as recessions, trade wars, and inflation. Narrative sentiment can vary depending on the tone and volume of coverage.

Even if you are a quant, you should read the news and stay aware of current market narratives. However, these narratives can be systematically measured and incorporated into a model to increase explanatory power. We always knew this was the case, but the key finding is that narrative sentiment persists and is independent of other factors.

Be situationally aware of what is being reported in the news, which can often be systematized. 

Global equity correlations falling - flows following cheapness

The overall tendency for correlation across global equity indices is high, given strong economic integration across countries and the multinational business of large-cap stocks. Nevertheless, we note the current decline in equity correlations. The US is obviously moving higher on tech (Mag 7) and strong valuations. We note that the Mag 7 is showing increased dispersion, and valuations outside of tech are more reasonable; however, perceptions and flows suggest a decoupling as investors look for cheaper investment opportunities. The theme of seeking international cheap valuations will drive investor focus in 2026.