Global stocks and bonds have fallen in tandem since mid-August as runaway inflation forced major central banks such as the Federal Reserve, Bank of England and European Central Bank to accelerate the pace of monetary policy tightening .
Policymakers have repeatedly signaled that they will continue to raise interest rates until they have tamed the worst inflationary pressures in four decades, but investors are increasingly concerned that the combination of monetary tightening and high energy prices will lead to an economic recession in the United States and the United States. Europe.
Year-to-date, the FTSE All World Index (including dividends) and the Bloomberg Global Aggregate Bond Index have fallen 16.8%.
This synchronized weakness has created problems for investors who model their portfolios on a classic “60/40” ratio, where three-fifths of their money is invested in stocks and the rest in bonds. This gives investors exposure to both the capital gains and dividends offered by stocks and the safe income stream of a bond.
Goldman Sachs warned in November last year that 60/40 portfolios could face a “lost decade” of returns below 5% if stock and bond valuations return to their long-term averages.
According to Goldman, 60/40 portfolios on both sides of the Atlantic have seen losses of around 15% over the past 12 months.
For example, Vanguard’s LifeStrategy Moderate Growth Fund – a global 60/40 strategy – has generated a total return (dividends and net of fees) of minus 14.9% in dollars so far this year. This decline reduced the fund’s annualized returns to 6.5% over the decade to the end of August.
Peter Oppenheimer, Goldman’s chief global equity strategist, said the rally in US stocks between mid-June and mid-August was a temporary “bear market” rally, so investors should prepare for more volatility. .
“We expect further weakness and bumpy markets before a decisive bottom is established,” he said, adding that investors would price in heightened recession risk as interest rates rise. interest continued to grow.
BlackRock also warns that recession risks are not yet fully priced into equity markets and that the threat of persistently high inflation rates is still underestimated by investors.
Jean Boivin, director of the BlackRock Investment Institute, says neither the Federal Reserve nor the ECB have grasped the depth of the economic downturn that will be needed to crush inflation.
But BlackRock also believes the Fed and ECB will be forced to stop raising interest rates “well below market projections” once the severity of the damage to the economy and jobs from the monetary tightening will become clearer.
That could leave the Fed’s preferred measure of inflation – the core personal consumption expenditure index, which excludes food and energy prices – at closer to 3% a year than the target. official 2%.
According to BlackRock’s current forecast, a global 60/40 portfolio should generate annualized nominal returns of 7.1% over the next decade. But net returns to investors will inevitably be lower if central banks fail to control inflation.