Some commentators have written off the traditional 60/40 portfolio mix between stocks and bonds as unfit for a decade of wild moves in fiscal and monetary policy. While the era of low volatility is over and market dislocations will likely be more frequent and violent than in the past, that doesn’t necessarily spell the end for investors’ favorite portfolio strategy. It just needs an update for this new investing era.
The crux of the problem is the changing correlation between stocks and bonds. If these are inversely correlated, then bonds appreciate when stocks sell off, making them a useful diversifier. That was the case from 2000 to 2021. But in 2022, the pattern broke. Stocks and bonds fell together, much to many investors’ dismay. What many missed is that in a period of high inflation, the Federal Reserve will hike interest rates to cool the economy, causing stocks and bonds to move down together. Runaway fiscal profligacy leads Treasury issuance to surge and increases the market term premium required to absorb bond supply, which again pushes stocks and bonds down together. This has happened recently.
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Stephen Miran is an adjunct fellow at the Manhattan Institute, co-founder of asset manager Amberwave Partners, and a former senior adviser for economic policy at the U.S. Treasury, 2020–21. Max Golts is co-founder at 4x4invest, an asset management and consulting firm.
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