“We expect new highs in yields and new lows in stocks.”
That was the message from BofA’s Michael Hartnett, who painted a somewhat grim picture in the latest installment of his popular weekly “Flow Show” series.
Much of the story is familiar. Hartnett sees a regime change — an epochal shift in global trade dynamics, geopolitics and power relations between economic actors. Together, it argues for a secular de-rating in equities.
A 21st century multiple on trailing earnings gets you S&P 4,400. A 20th century multiple, by contrast, gets you 3,300 (figure below).
“We say the drivers of high 21st century P/Es are all reversing,” Hartnett wrote, reiterating a familiar narrative. “QE, fiscal austerity, free movement of trade, people, capital, geopolitical peace” are all passé.
The “new regime,” Hartnett said, is defined by elevated inflation, “which means the secular view remains cash, commodities and volatility will outperform bonds and stocks.”
Notably, Bloomberg’s global bond index is officially in a bear market (figure below). The 20% drawdown is the largest since the gauge’s inception more than three decades ago.
The read-through for traditional balanced portfolios isn’t particularly encouraging. A simple stock-bond portfolio is staring at the worst returns since the financial crisis, down more than 15% in 2022 amid the simultaneous drawdown in equities and investment grade fixed income.
An entire generation of investors came to regard the stable correlation underpinning 60/40 strategies as something akin to a natural law. But, like so much of what we take for granted, the “have your cake and eat it too” promise of balanced stock-bond portfolios was a byproduct of The Great Moderation. Generally speaking, the two assets were negatively correlated but nevertheless rallied simultaneously over a prolonged period. Things that seem too good to be true usually are.
“We are in a new investment environment,” one fixed-income manager in Sydney told Bloomberg, calling this “a huge deal for those expecting fixed income to be a diversifier to risk-off in equities.”
It is indeed “a huge deal.” And it’s a microcosm of the discussion from “What If ‘Normal’ Isn’t What We Think It Is?”
Our assumptions about “bedrock” asset allocation principles are no different from our assumptions about the purported “normalcy” of peace and prosperity across much of the developed world since the mid-80s: They’re a manifestation of naive recency bias. A product of an anomalous period of relative stability. That period may be over.