Adapt or die: the mantra of financial markets


Bloomberg published an interesting article this week on how the 60/40 equity-to-bond ratio that has been the foundation of many investor portfolios may be dead. The reason is if we see a stagflationary environment where inflation is high, but growth is slow. Check out this helpful cradle sheet from the folks at Financial Source to help you see the different results.

The worry is that rising inflation will see central banks around the world looking to slow their economies down by raising interest rates. This will hurt both bonds and stocks. The low growth era of the last 20 years or so has boosted the 60/40 strategy because it is based on the principle that rising stocks = falling bonds and vice versa. In September, bonds and stocks fell together.

Graphic

Now the caveat with this of course is whether inflation is really transient. We know central banks are increasingly abandoning the word “transitional”, but the problems that fuel inflation are not insurmountable. Supply chain issues can be solved. Oil prices can fall due to the increased supply, and natural gas prices can return naturally even during the warmer months. So, in these situations, changes in day-to-day narratives can be negotiated intraday. However, the longer question remains: “Will inflation rise further in a world dominated by automation and globalization?” It is difficult to say “yes” with conviction. So maybe inflation is transient, but transient can mean 2-3 years. So it all depends on your timescale and your benchmark.

In the short term, it may be worth turning to gold. If inflation is rising faster than yields, it will force real yields to fall. If the USD then starts to fall, that’s fuel for gold. It is therefore a key market to watch for the future.

Gold

However, the lesson is clear. Sometimes markets change quickly. When they do, it’s about adjusting with them if necessary.


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