October 4, 2022
Market downturn challenge for 60/40 portfolio

Global stocks and bonds have been falling with galloping inflation since mid-August, forcing major central banks such as the Federal Reserve, the Bank of England and the European Central Bank to speed up monetary policy tightening.

Policymakers have indicated repeatedly that they will continue raising interest rates until they overcome the worst inflationary pressures in four decades, but investors are increasingly fearing monetary tightening and higher inflationary pressures. The combination of energy prices will lead to an economic slowdown in both the US and the US. Europe.

Since the start of the year, both the FTSE All World Index (including dividends) and the Bloomberg Global Aggregate Bond Index have lost 16.8 per cent.

This synchronous weakness has created problems for investors who model their portfolios on the classic “60/40” ratio, where three-fifths of their money is invested in equities and the rest in bonds. It provides investors with exposure to both the capital gains offered by stocks and the safe income stream of dividends and bonds.

Goldman Sachs warned in November last year that a 60/40 portfolio could face a “lost decade” of returns of less than 5 percent if stock and bond valuations return to their long-time averages.

According to Goldman, 60/40 portfolios on both sides of the Atlantic have posted losses of about 15 percent over the past 12 months.

12-Month Drawing Line chart of the Standard 60/40 Portfolio in the US and Europe (%)

For example, Vanguard’s LifeStrategy Moderate Growth Fund — a global 60/40 strategy — has delivered total returns (including dividends and fees) of minus 14.9 percent in dollar terms so far this year. That decline has reduced the fund’s annual return to 6.5 percent for the decade to the end of August.

Peter Oppenheimer, chief global equity strategist at Goldman, said the recovery of US stocks between mid-June and mid-August was a temporary “bear market” rally, so investors should be prepared for more volatility.

“We expect further weakness and bumpy markets before a turning trough is established,” he said, adding that investors will pay the price in more bearish risk as interest rates continue to rise.

BlackRock also warned that bearish risks are yet to be fully valued in equity markets and the risk of persisting high inflation rates is still being underestimated by investors.

Jean Boivin, head of the BlackRock Investment Institute, says neither the Federal Reserve nor the ECB understood the severity of the economic slowdown that would be necessary to crush inflation.

But BlackRock also thinks that both the Fed and the ECB will be forced to stop raising interest rates “far below market estimates” when the severity of the damage to the economy and the monetary tightening of jobs becomes clear.

This could leave the Fed’s preferred measure of inflation – the main personal consumption spending index, which does not include food and energy prices – running closer to 3 percent annually compared to the official 2 percent target.

BlackRock’s current forecast is for a 60/40 global portfolio to deliver an annual nominal return of 7.1 percent over the next decade. But if central banks are not successful in controlling inflation, the net return to investors will inevitably be lower.

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