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 3. U.S. & Canada
 4. Market Extra


MARKET EXTRA




STAGFLATION IS RAISING THE RISK OF ‘LOST DECADE’ FOR 60/40 PORTFOLIO OF STOCKS
AND BONDS, GOLDMAN SACHS SAYS

Published: March 18, 2022 at 1:36 p.m. ET
By

VIVIEN LOU CHEN

  comments


‘THE DEMISE OF THE 60/40 PORTFOLIO HAS BEEN A LONG TIME COMING, AND IT’S FINALLY
HERE,’ SAYS JOHN SILVIA OF DYNAMIC ECONOMIC STRATEGY

MOTORISTS LINED UP ON THURSDAY FOR FREE GAS AT A FILLING STATION IN THE HUMBOLDT
PARK NEIGHBORHOOD OF CHICAGO AFTER BUSINESSMAN WILLIE WILSON PROMISED TO GIVE
AWAY $200,000 IN GAS AT A VARIETY OF STATIONS.

Scott Olson/Getty Images
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REFERENCED SYMBOLS


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GS
+0.61%
TMUBMUSD10Y
2.233%
TMUBMUSD02Y
2.015%

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Rising stagflation risks in the U.S. and Europe are raising the possibility of a
“lost decade” for the 60/40 portfolio mix of stocks and bonds, historically seen
as a reliable investing choice for those with moderate risk appetites.

Such a “lost decade” is defined as an extended period of poor real returns, says
Goldman Sachs Group Inc. GS, +0.61% portfolio strategist Christian
Mueller-Glissmann and his colleagues Cecilia Mariotti and Andrea Ferrario. Since
the start of 2022, 60/40 portfolios in the U.S. and Europe are down more than
10% in real terms, the Goldman team wrote in a note released Friday.

Risks of slower growth plus inflation are being amplified by the ongoing Russian
invasion of Ukraine, and are already taking a toll on many investors. The three
major U.S. stock indexes are off by 5% to 12% this year, with the tech-heavy
Nasdaq Composite COMP dropping the most. Meanwhile, bonds are also having a
rough time — with the 10-year Treasury note TMUBMUSD10Y, 2.233% putting in its
worst year-over-year performance since 2013 as of Thursday, which has pushed its
yield above 2.1%. That’s diminished the performance of the 60% allocation to
equities and 40% allocation to bonds.

Signs of stagflation worries are evident in rates markets. The 10-year U.S.
breakeven inflation rate, a gauge of inflation expectations, has reached its
highest level since the 1990s, according to Goldman Sachs. Meanwhile,
inflation-adjusted real yields remain near their lowest levels in decades,
reflecting pessimism about economic growth in coming years. And the widely
followed spread between 2-year TMUBMUSD02Y, 2.015% and 10-year Treasury yields
is inching its way closer to an inversion, typically a harbinger of recession.


Datastream, Haver Analytics, Goldman Sachs Global Investment Research

“The No. 1 problem with the 60/40 portfolio is that the pace of inflation means
real returns on the bond side will be negative,” said John Silvia, founder and
chief executive of Dynamic Economic Strategy in Captiva Island, Fla. “And slower
economic growth means slower profit growth, which means the stock side of the
portfolio gets hit as well.”

“So the total portfolio performance will probably be disappointing relative to
past years, and it could entirely last a full decade,” Silvia said via phone.
“The reason is that you’ve had arbitrarily low interest rates for four to five
years, and a lot of speculation in the marketplace with people reaching for
yield. The demise of the 60/40 portfolio has been a long time coming, and it’s
finally here.”

The lost decade envisioned by Goldman Sachs marks a turnabout from the last
cycle, which benefited from what Mueller-Glissmann and colleagues call a
“structural ‘Goldilocks’ regime.” That’s when low inflation and real rates
boosted valuations and profit growth, despite relatively weak economic growth.
Equities and bonds each performed well side-by-side — with real returns on the
60/40 mix coming in at roughly 7% to 8% each year during the last cycle,
compared with a 5% long-run average, they said.

The thinking behind the 60/40 mix in the first place has been the notion that
bonds can act as ballast to the riskiness inherent in equities. Private pension
plans are one investor category that has continued to cling to the mix and have
“rarely deviated from it,” according to Deutsche Bank researchers.

But lost decades are more common than many think, according to
Mueller-Glissmann, Mariotti and Ferrario. They’ve occurred during World War I,
World War II and the 1970s — following strong bull markets marked by elevated
valuations. And the likelihood of a lost decade rises in the face of
stagflation, they said.

The following chart reflects 1-year and 10-year drawdowns in the 60/40 portfolio
through the decades.



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Datastream, Haver Analytics, Goldman Sachs Global Investment Research

A combination of other investments can help reduce the risk of another 60/40
lost decade for investors, the Goldman team said. They include allocations to
“real assets” such as commodities, real estate and infrastructure, as well as
greater diversification in overseas markets. Investors should also consider
value and high-dividend-yielding stocks, as well as convertible bonds, according
to Goldman.

To be sure, not everyone’s on board with the idea of a prolonged period of poor
60/40 returns. Thomas Salopek, a strategist at JPMorgan Chase & Co. JPM who
warned in January that the 60/40 mix was “in danger,” says he thinks the U.S.
will avoid actual stagflation. “We believe,” he said, “there will be no lost
decade for the 60/40.”

“For now, the environment is still high growth and high inflation,” he wrote in
an email to MarketWatch on Friday. With yields historically rising during a Fed
rate-hike cycle, “there is a healthy stock vs. bond risk premium that can
finally be harvested as risk aversion recedes. So stock outperformance should
more than make up for bond weakness, once risk appetite recovers.”

On Friday, Treasury yields turned mixed as investors factored in the prospects
of slower growth.









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READ NEXT


READ NEXT


GOLD AT $10,000? DEATH OF THE 40-YEAR BULL MARKET IN BONDS? WHAT’S NEXT FOR THE
GLOBAL FINANCIAL SYSTEM AFTER RUSSIA’S CENTRAL BANK GETS CANCELLED

The shockwaves are still being felt by the incredible Western sanctions on
Russia that have rendered the $630 billion in reserves the Russian central bank
accumulated virtually unusable.


MORE ON MARKETWATCH

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ABOUT THE AUTHOR

Vivien Lou Chen


Vivien Lou Chen is a Markets Reporter for MarketWatch. You can follow her on
Twitter @vivienlouchen.



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