Wishful thinking is never a great investment strategy. But in the current macroeconomic environment, we can be forgiven for wanting to go back to the tried and true.
Take the
But this year, major media outlets have declared that the
So it's worth asking the question:
As we all know, in 2022 rates went up substantially for the first time in a long time. Inflation, which the Fed had initially thought a transient phenomenon, turned out to be very real. As a result, the Fed embarked on a series of rising rate moves in an attempt to bring inflation back down to an acceptable level. But when viewed on a 40-year chart, 2022 looks like a big aberration, especially since the first half of 2023 is holding its own in terms of equities.
But equities behave differently than bonds. Most of us can agree that buying equity on dips for 60% of your portfolio makes good sense because equities, in aggregate, have a long track record of going up over time. Bonds, however, do not have the same track record, and private investors should not expect that bonds will appreciate in price over a very long time frame. Yes, interest rates rose significantly in 2022, but they remain below historical averages and are still a fraction of the level seen in the late 1970s. Given this longer-term lens, investors should be aware that the shock-absorber protection we have enjoyed during times of market dislocation shouldn't be relied on going forward.
Will bonds provide the buffer we grew to expect, or will there be times that look more like 2022? Certainly, bonds are more attractive than they were in 2022, giving some credence to recent calls on the 60/40 strategy's comeback. Those calls may ultimately prove correct, but it's just too soon to know whether 2022 was truly an aberration or a sign of things to come.
And that is my point. Guessing which way the financial winds will blow is never a great strategy. In the absence of certainty, the prudent investor should always have a caveat emptor mindset. In other words, those who are considering diving back into 60/40 strategies at this point need to be careful of the longer-term risk. After all, the macroeconomic forces that have driven the rise in inflation and rates are still quite unpredictable. What's more, it is certainly possible that rates have bottomed, and we will not see rates close to zero again for some time, if ever.
Advisors navigating these more complex terrains with their clients should consider diversifying client portfolios with investment options that have low or no correlation to stocks and bonds and have a track record of delivering positive performance in periods of dislocation. This way, their portfolios may benefit from being buffered against market dynamics which may — or may not — lead the prudent investor back to a 60/40 allocation.
While there are few liquid options that can provide this type of diversification, risk protection and non-correlated performance, two options are global macro and trend-following programs. Both strategies behave a lot like the fixed-income component of a traditional 60/40 portfolio. They are designed to generate long-term returns while at the same time provide potential downside protection in periods of market dislocation. Unlike traditional investment approaches, these strategies are agnostic to market direction, and their toolkits expand to include FX and commodity markets where risks of inflation, volatility spikes, equity sell-offs and other shocks can be harnessed as opportunities.
