About every two years, the stock market falls by at least 10%.
It’s been about seven months since the last such drop, and many experts say another may come soon. They say that earnings estimates are overly optimistic and valuations are overdone.
Analysts’ outlook for S&P 500 second-quarter earnings, blended with earnings that already have been reported, points to profit growth of 9.3% from a year earlier, according to FactSet.
As for valuation, the forward price-earnings multiple for the S&P 500 was 21.4 as of July 12. That easily exceeds the five-year average of 19.3 and the 10-year average of 17.9. “Forward” refers to earnings for the next 12 months.
That raises some questions for investment pros and may make Vanguard's take on a popular investment strategy even more prescient.
TheStreet
TheStreet Pro's Doug Kass on stocks
TheStreet Pro columnist Doug Kass is one of the bears. His view carries great weight given his career as a hedge-fund manager going back to the 1970s. That includes a stint as director of research at the legendary investor Leon Cooperman's Omega Advisors.
The market is “flying too close to the sun,” Kass wrote in a TheStreet Pro commentary. He was referring to the mythological character Icarus, whose wings melted when he flew too close to the sun.
Kass notes that interest rates have risen this year, notwithstanding the recent decline. The 10-year Treasury yield has jumped 0.35 percentage point to 4.22% during that period.
Related: Top Wall Street analyst issues stark warning for stocks
That makes bonds attractive compared to stocks. The S&P 500 dividend yield totals 1.28%, compared with a 5.18% yield for six-month Treasury securities.
Another bearish signal: Five top technology stocks account for about 60% of the S&P 500’s return this year, Kass points out.
They are semiconductor sultan Nvidia (NVDA) , search king Alphabet (GOOGL) , social media titan Meta Platforms (META) , software stalwart Microsoft (MSFT) and retail/technology colossus Amazon (AMZN) .
“Not since the 1960s have five stocks accounted for so much of the total market return,” Kass said. “We should learn from history, as these divergences have ended badly and unexpectedly.”
Vanguard is a fan of the 60/40 portfolio
So, how do you protect yourself from a stock market downturn? One way is by holding bonds, which provide regular income that can cushion you from falling equities.
The historical rule of thumb is that investors should devote 60% of their investment portfolio to stocks and 40% to bonds.
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That strategy hit a roadblock in 2022 when stocks and bonds both dropped amid the Federal Reserve’s interest-rate hikes. Money-management giant Vanguard’s 60-40 model portfolio dropped 16% that year.
This led investors to question the strategy, with some even saying it was obsolete.
However, the portfolio has rebounded since then, with stocks rising and bonds tempering their price losses while offering higher yields over the past 18 months.
According to Vanguard, the 60-40 strategy has posted a 20.5% cumulative return from January 2023 through May 31, 2024. The annualized return over the past decade is 6.2%.
Vanguard’s 60/40 portfolio outlook
Looking to the future, “we see the strategy as poised for another strong decade ahead,” Todd Schlanger, senior investment strategist at Vanguard, wrote in a blog.
“While strong equity returns had an outsized impact on the 60-40 over the last decade, the next decade is likely to be more balanced.”
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Some experts expect the Federal Reserve to cut rates but leave them higher than in recent years. So, investors may benefit from rising bond prices and still-buoyant interest payments.
Schlanger emphasizes a focus on the long run. “It’s easy to get caught up in the noise and year-to-year returns,” he said.
“That’s why we encourage our clients to focus on what they can control – their goals, asset allocation, costs, and the discipline which they implement their investment strategy.”
Schlanger likes 60-40 as a basis for a diversified portfolio. “It has been a remarkably consistent performer over the long term.”
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