Jim Caron, who serves as the chief investment officer for Morgan Stanley Investment Management’s portfolio solutions team, suggests that those relying on the classic 60/40 portfolio of stocks to bonds might need to reconsider their approach given the current economic climate. This year has been marked by market swings, largely due to traders grappling with the U.S. economic situation and the ripple effects of the Trump administration’s trade policies and tariffs.
The 60/40 portfolio strategy has traditionally been effective for the last decade or so mainly because it operates passively and thrives when bonds aren’t closely linked to equities. However, Caron points out that the landscape has shifted. He mentions, “If you look at the three-year rolling correlation between stocks and bonds, it’s at a historic high — the highest in over a century.” Essentially, this means that when the correlation is strong, both bonds and stocks tend to move in the same direction, either up or down.
In light of this, Caron advises investors to actively balance the volatility between bonds and equities. “It’s not a matter of sticking rigidly to 60/40; it needs to be more adaptive,” he emphasizes. Depending on market conditions, the allocation might swing to configurations like 40\% bonds/60\% stocks or other combinations including 20/80. Sticking with a passive 60/40 could lead to missed opportunities for higher returns, he warns.
Historically, from 1981 to 2021, this strategy yielded an average annual return of about 7.5\%. Yet, with interest rates stabilizing, bond gains are more likely to come from coupon payments than price appreciation. If stocks return an average of 7\%, the combined 60/40 allocation is likely to result in a total return around 5\%. Caron explains the long-term impact of this: “A consistent 7\% return would double your money every decade, but a 5\% return stretches that to 15 years.”
Currently, Caron favors a slightly tweaked allocation of 55\% stocks with 45\% in fixed income. However, what’s crucial is the composition of these investments. His equity preference leans towards the equal-weighted S&P 500, accessible via the equal-weighted S&P 500 ETF (RSP). “This approach underweights large-cap tech and overweights large-cap value, mid-caps, and broader market segments,” notes Caron.
Caron also sees potential in European equities, which he views as a large-cap value play. Moving to an overweight position in February, he was encouraged by signs of pro-growth policies and deregulation from European leaders. Such political shifts are, in his words, significant “game changers,” particularly for energy needs given Europe’s reindustrialization push.
On the fixed income front, Caron adopts a barbell strategy with high-quality, short-duration bonds plus some high-yield exposure. Overall, the firm maintains an investment-grade status, favoring Treasurys, short-term corporate bonds, and agency mortgage-backed securities (MBS) for high-quality investments, and non-agency MBS and bank loans as additional options.
