The market has been full of talk about stagflation — low growth combined with high inflation — for months, and the Russia/Ukraine war has only increased concern about it.
Strategists at Goldman Sachs cite several ominous signs.
The U.S. 10-year break-even rate, a measure of inflation expectations, has reached its highest level since the 1990s, while real yields remain near their lows, they note in a commentary.
Low real yields can be a sign of high inflation and slow growth.
“There is also a large gap between cyclical-stock versus defensive-stock performance and inflation expectations, especially in Europe,” the strategists said. “This points to little optimism on growth and large concerns over inflation risk.”
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All that doesn’t bode well for the standard 60%-stock/40%-bond portfolio, the strategists said.
“Stagflation increases the risk of a ‘lost decade’ for 60/40 portfolios, i.e., a prolonged period of poor real returns,” they wrote. “It is the opposite of the last cycle, which was like a structural ‘Goldilocks’ regime.”
The strategists are referring to the gains for stocks and bonds in recent years.
With bonds offering lower real returns and little diversification benefits, investors will have to hold higher equity weightings and lower bond weightings than in the last cycle, the strategists said.
“To reduce the risk of poor real returns in the medium term, investors may have to accept more risk in the near term,” they wrote.
A range of investments can help investors cope with the lessened effectiveness of a 60/40 portfolio, Goldman strategists said.
They specified commodities, real estate, infrastructure, more international diversification, value and high-dividend stocks and convertible bonds.
That combination “could help reduce the risk of another 60/40 ‘lost decade’ and improve the real risk/reward for multi-asset investors,” the strategists said.
“With elevated and sticky inflation globally, we continue to prefer real to nominal assets,” they said. “In the 60/40 drawdown year-to-date, allocations to real assets such as commodities, infrastructure and real estate helped buffer losses.”
