60/40 in an era of American Unexceptionalism

Posted by Cam Hui -
Preface: Explaining our market timing models

We maintain several market timing models, each with differing time horizons. The “Ultimate Market Timing Model” is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

 

The Trend Asset Allocation Model is an asset allocation model that applies trend-following principles based on the inputs of global stock and commodity prices. This model has a shorter time horizon and tends to turn over about 4-6 times a year. The performance and full details of a model portfolio based on the out-of-sample signals of the Trend Model can be found here.

 

 

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don’t buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the email alerts is updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

 

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities (Last changed from “sell” on 28-Jul-2023)
  • Trend Model signal: Bearish (Last changed from “neutral” on 11-Apr-2025)
  • Trading model: Bullish (Last changed from “neutral” on 28-Feb-2025)

Update schedule: I generally update model readings on my site on weekends. I am also on X/Twitter at @humblestudent and on BlueSky at @humblestudent.bsky.social. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of those email alerts is shown here.
 

Subscribers can access the latest signal in real time here.

 

 

Threats to the 60/40 Portfolio

The conventional asset mix of 60% equities and 40% bond is designed to maximize return and minimize volatility risk under a reasonable set of risk tolerance assumptions. The equity portion of the portfolio is meant to provide growth, while the bond portion is designed to provide portfolio stability as bond prices have low to negative correlation to stock prices. In addition, bonds have the additional benefit of a steady income and high assurance of capital preservation, or getting your money back.

 

What happens if the “getting your money back” assumption is shaken?

 

Investors saw that recently when Treasury yields rose (and Treasury prices fell) and the USD fell at the same time. The episode was interpreted as a possible end to the era of American Exceptionalism and the USD as a safe-haven asset. While we saw a similar episode in early 2018, it nevertheless underscores concerns about the 60/40 portfolio as stock bond correlations were rising in both instances. Rising correlation leads to greater portfolio volatility and a reduction in the diversification effects of the two asset classes, which can be worrisome during the current climate of elevated market stress.
 

 

What can investors do under such circumstances?
 

 

The Price of Diversification

If the market is losing confidence in the USD and Treasury assets, investors can diversify into a portfolio of non-U.S. sovereign bonds as an alternative. U.S.-based investors should consider the iShares International Treasury Bond ETF (IGOV), which is designed to track the FTSE World Government Bond Index–Developed Markets Capped (USD). Here are the characteristics of IGOV from iShares.
 

 

The characteristics of IGOV are similar to the 7–10 Year Treasury ETF (IEF). The effective duration, or interest rate sensitivity, of both are similar, though IGOV shows a much lower weighted average coupon of 2.23% compared to 3.84% for IEF.
 

 

Diversification has a price in addition to the obvious substantial reduction in average coupon rate. IGOV has underperformed IEF in the last 10 years, though its relative performance popped in the wake of the latest scare (black line, top panel). Foreign bonds provide some inflation protection against domestic bonds through the foreign exchange channel. The accompanying chart also shows the relative performance of TIPs against IEF (red dotted line). The relative performance of TIPs and IGOV were closely correlated until they diverged in mid-2021.
 

 

A U.S. investor concerned about the decline of American Exceptionalism can consider a basket of IEF and IGOV for the bond portion of his 60/40 portfolio. As IGOV has surged against IEF and looks extended on a relative basis, investors seeking to diversify their holdings should average into their IGOV positions over the next few months.
 

On the other hand, fears about the USD could be a head-fake. These covers of The Economist, which were published six months apart, could be the bookends of the perfect contrarian magazine cover signals.
 

 

 

A Cautious Outlook

Nevertheless, I believe the bond portion of a portfolio is becoming increasingly important. Consider the following mystery chart. The top panel is the S&P 500 over the past year, but what are the constructive patterns of the other panels?
 

 

Mystery revealed: They are the relative performance of defensive sectors, which (from top to bottom) is healthcare, consumer staples, utilities and real estate. The constructive patterns of relative performance of these sectors are indicative of a longer-term bear market structure of the U.S. equity market.
It’s time to be more defensive.

 

To be sure, sentiment models are showing substantial levels of fear.
 

 

The latest AAII sentiment survey shows another week of extreme anxiety.
 

 

An analysis of insider activity shows that insider buying (blue line) recently came within a hair of insider selling (red line). In the past, such signals have resolved in price rebounds of differing durations.
 

 

On the other hand, forward 12-month earnings estimates look wobbly as Q1 earnings reporting season begins. With only 12% of S&P 500 companies reported, the EPS and sales beat rates are below historical averages.
 

 

CNBC reported that shipping volumes to the U.S. are collapsing in the wake of the substantial increase in tariff rates. Left unchecked, this will lead to COVID-era supply chain bottlenecks in the coming months.
 

 

Earnings season begins in earnest in the coming week with Magnificent Seven Tesla and Alphabet reporting. Stay tuned.
 

 

Putting it all together, I believe that the current market trajectory will follow the script of bear market rallies of the dot-com bear of 2000, 2008 GFC bear, 2022 inflation fear bears of a substantial drop, a massive bear market rally, and a probable break to new lows. Trump’s tariffs will cause massive dislocations in the economy in the coming months. Anecdotal evidence from ports data will push CPI to an annualized 4% and beyond starting with the April report. Trump realizes this, and that’s why he lashed out at Powell last week by citing the backwards looking benign inflation backdrop. As price pressures and shortages build, it will put the Fed in a difficult position and a debate about whether it should look trough the one-time price rise. Barring significant progress on the trade war front, the higher for longer narrative and weaker economic outlook will weigh on risk appetite.

 

In conclusion, I interpret the combination of technical, sentiment and fundamental conditions as the stock market being ripe for a short-term relief rally, but it is at substantial risk of a much deeper downdraft as more difficult macro conditions become evident.Tactically, the market is trying to recover from a severely washed-out and oversold condition and it’s ripe for a short-term rebound. The short-term challenge for the bulls is to stage an S&P 500 upside breakout through the falling trend line (blue), followed by a breakout of the 50% Fibonacci retracement level at 5500. That said, the minor short-term positive divergence of the NYSE Advance-Decline Line is constructive for the bull case.

 

 

5 thoughts on “60/40 in an era of American Unexceptionalism”

  1. Both IGOV and IEF have long durations (over seven years) and will therefore be susceptible to rising interest rates. With the yield curve on the verge of inverting, why not buy some T-bills? They yield over 4% and can be rolled over every three months or sold at any time due to their liquidity. If T-bills become unsafe, we have a lot more to worry about then interest income.

    1. I have some SGOV, I’m too lazy to keep renewing them every few months. I have thought of going to treasury direct to do it myself, but the cost of SGOV is not very much. Maybe I am wrong, but that’s my position.
      Duration is my concern. If 5 year bonds gave 10%, then I would have a hard look, but for the current difference, it’s not worth the risk.
      If you want low risk with cap gains potential buy something like a TLT LEAP. I have not done that BTW.

  2. Was it Taleb who talked about fragility and anti-fragility?
    Remember in the GFC how GS and others got bailed out by the Fed? That was my introduction to counterparty risk that registered. 1987, LTCM did not, I don’t know why.
    In any case, I think that derivatives have increased, and so we have chains with increasing links, some of which will turn out to be weak.
    It is the dark side of finance, that players can make huge sums of money and yet if things go bad they can walk away so long as they did not do criminal acts. Is it any surprise that things can go wrong? Consider CEOs and what they get paid even if the company goes bust. Stock buybacks simply mask the dilution all those stock options would cause. What is the amount that goes into buybacks? 1 trillion a year or something of that order. If that trillion went into dividends what would the yield on the S&P be?
    When interest rates are really low, borrowing is attractive. When it goes on for over a decade, a lot of debt builds up, with chains of derivatives binding everything…what could go wrong?
    Wherever you live, you need the currency of your country. If that currency is really weak then you need some insurance, but remember that when you want food or to pay your expenses you need money in your currency.
    As a person who grew up in Canada, I have experienced walking on ice and hearing it crack. It doesn’t always break, and if you are in a field where the water underneath is really shallow, it’s kinda fun. On a lake, you fall through and you can drown or if you get out die of hypothermia before finding safety.
    Feels like the market is cracking.

    1. With or without Trump, it is going to crack anyway. Trump doesn’t just jump out of a crack of a big stone. All conditions have to be there for a guy like Trump to ascend to the position of power. He is just the spearhead of the trend change. It is so simple. The current global setup is just not sustainable. If it is not sustainable it will stop eventually. Something will happen, and many will not be happy while the long suffering people under the current setup will support the change. It is not a question of whether you like it or not. The force is much bigger than you can resist. Canada for example is going to polls these days for new (or continued old) leadership. If Poilievre wins then Canada might adjust a little bit but still very difficult to turn it around. If Carney previals, it will get very interesting. Carney is the designers (as part of WEF cabal) of Trudeau’s policies the last 10 years but Trudeau is bad at execution efficiency. Carney will be much better at it. Will it be better for Canada? I really don’t know. Canada’s problems are now deeply structural.

      For our fellow Canadians readers here, I am not advovating for any ill things happening to Canada. I have Canadian friends (both English and French speaking) and worked with Canadian engineers before. To me it is all about the results, regardless of ideology. But this is not limited to Canada alone. Look at majot countries in Western Europe, France and Germany. The recent elections in both countries saw more conservative voters growing fast. But they have no say in the federal level. This is dangerous becaue it is perceived as suppression by these voters. The next time they will be back more forcibly. The more dire situation is in UK. Now more and more Brits perceive it as a two-tier country and the Gov and the Monarchy are on the other side. You can already see the skirmishes everywhere, possibly at the stage one.

      Yes it is a time of great change. It will happen much faster as that is the hall mark of the Internet age. No one is sure of anything. Be conservative and lower the expection.

  3. Cam, can you please do some house keeping and correct the “Trading Model” to reflect what you have written about in posts, charts and comments.

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