The Random Quilt of Wall Street

Nick Levinson Comments, Life with Money

A picture is worth a thousand words, as the old saying goes.

The “quilt” chart below, prepared by JP Morgan Asset Management, colorfully demonstrates many of the points Park Piedmont Advisors has made over the years. Several of them derive from Burton Malkiel’s 1973 classic, A Random Walk Down Wall Street:

  • While the stock and bond markets have produced positive returns over many decades, the year-to-year variability can be large, and is impossible to predict
  • Different parts of the stock and bond markets produce returns with wide variability over short time periods
  • A broadly diversified portfolio has less extreme ups and downs while producing competitive long-term returns

JP Morgan's Asset Allocation Quilt Chart
The “quilt” chart details returns from 2008 through 2023 for nine components of the stock and bond markets, plus an “asset allocation” benchmark comprised of varying percentages of all nine. More precisely, we would characterize seven of the nine components as “riskier” investments, which are often associated with stocks.

These seven include:
 US large company stocks (green on the chart)
 US small company stocks (orange)
 international developed company stocks (grey)
 emerging market company stocks (light purple)
 real estate related stocks, referred to as REITs, or real estate investment trusts (light blue)
 commodities, including gas, oil, precious metals, and agriculture (dark green)
high-yield income, a hybrid of stocks and bonds that often performs more like stocks in declining markets (blue)

The two “less risky” categories include:
 intermediate-term bonds, often also referred to as “fixed income” (dark blue)
short-term cash (purple)

Based on these characterizations, asset allocation (white on the chart) consists of 65-70% riskier assets and 30-35% of less risky assets.

Here are a few of our more specific observations:

Risk-Return Tradeoff

  • As expected, the 15-year return figures (far left of the chart) show all the riskier assets at the top, with the less risky assets at the bottom.
  • Similarly, the riskier assets have the highest measures of volatility (second column from left on the chart), which generally indicates the extent of the highs and lows generated by these assets. Bonds and cash have the lowest volatility measures.
  • In general, higher expected returns go hand in hand with high levels of risk.

Benefits of Diversification

  • The asset allocation benchmark is in the top half of the 15-year returns and the bottom half of the volatility measure. This doesn’t mean that a diversified portfolio eliminates risk, but it does show that owning some of all of the categories appears to reduce risk.

Stocks Can Generate Outsized Returns, both Positive and Negative

  • Note the strong performance of various segments, especially after the down years of 2008, 2018, and 2022. These upswings after downturns demonstrate one of our favorite concepts, “reversion to the mean.”
  • Also note that largecap US, smallcap US, emerging markets, and REITs have all been the top performers in various years.
  • Different stock segments have also been the worst performers during market declines.
  • Correct predictions from year to year involve more luck than skill, and are invariably unsustainable.

Bonds Have Offset Stock Declines in the Past, but not in 2022

  • Fixed income and cash were top performers in 2008 and 2018, and to a lesser extent in 2011 and 2015, when stocks also declined. And bond results were actually positive in those years, as opposed to simply less negative than stocks.
  • This relationship collapsed in 2022, as interest rate increases led to significant bond price declines. According to the Barclay’s U.S. Aggregate Bond Index, 2022 was the worst year for bonds since they started recording in 1976.

Why Invest in Commodities at all?

  • The 15-year returns are flat, and commodities have been at the bottom of the chart for the majority of the time.
  • But when inflation spikes, as it did in 2022, commodities often serve as a hedge against broad price increases in the economy. This is another example of the potential benefits of broad diversification.

We encourage you to review this fascinating asset class quilt chart in detail. Please let us know if you have any questions or comments.