Don’t expect 2020 to produce the same multi-asset returns as 2019.
That’s likely to be a common refrain headed into the new year, and really, it’s just common sense.
One of the most striking (if predictable, considering the evolution of monetary policy) features of markets this year has been the extent to which equities have found something to like in whatever bonds happen to be “saying” at a given time. We talked at some length about this on Thursday. To wit:
When bonds rallied (yields fell), stocks rose because the proximate cause of falling yields (i.e., trade uncertainty, subdued inflation and signs of economic deceleration) was also a reason to expect a decisively dovish turn from central banks.
When bonds sold off (yields rose), stocks rallied because the proximate cause of rising yields (i.e., optimism around a resolution on the trade front and expectations of better economic data) was a reason to think the cycle could be prolonged.
The result of that dynamic has been blockbuster returns for simple, balanced portfolios. In fact, this has been the best year since the crisis for a 60/40 fund (on the heels of 2018, which was the worst).
Naturally, this has been good for risk parity.
“The real winners of 2019 were risk parity strategies”, Goldman writes, in their multi-asset strategy outlook for 2020. After observing that “rolling return/volatility ratios for a US 60/40 portfolio were 2.4x, below the 4.3x from 2017, but one of best since the 1960s”, the bank notes that “a simple US risk parity strategy delivered a 4x return/volatility ratio in 2019 [and] returns for such a strategy would have been as strong as during the post-GFC recovery”.
At the risk of trafficking in nebulous platitudes, something’s got to give with that, and not necessarily because there’s some immutable law that says good times can’t keep rolling, but rather because with bond yields as low as they are, it’s hard to see much juice left there, no matter how much you lever up.
If we get any kind of inflection for the better in the macro, yields are likely to move higher (even if haltingly), and while equities would probably be fine with that (as long as any backup is breakeven-led), you shouldn’t be surprised if bonds have trouble in the first half of 2020, barring some kind of epic breakdown in the trade talks.
For Goldman, it makes sense to head into the new year with a “modestly pro-risk” lean.
“Equities offer the best return potential, in our view, although below-average risk-adjusted performance”, the bank said Friday, cautioning that “return opportunities in fixed income are limited”. The bank has shifted to UW bonds “and with poor asymmetry in credit”, they’re UW there too for 3M and neutral over 12.
In commodities, Goldman likes the carry and the diversification (they’re OW on a 12M horizon and neutral over 3M).
Oh, and they’re still OW cash on a 12m horizon because “with limited return potential across assets and bonds likely to be less good hedges in a ‘risk off’ environment”, why not?