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The Tell: Traditional 60/40 strategy may start to work again for investors, but ‘tightening cycles can be scary,’ Goldman exec says


The traditional allocation of 60% stocks and 40% bonds may start to work again, after such portfolios were badly hurt this year, according to Ashish Shah, chief investment officer of public investments at Goldman Sachs Group’s asset management business. 

Both equities and fixed income have been punished in 2022 amid fears over the Federal Reserve hiking interest rates to tame the highest inflation in decades. 

“Tightening cycles can be scary,” Shah said during a media briefing Monday afternoon on Goldman Sachs Asset Management’s investment outlook for 2023.

But “bonds are back,” with higher yields and spreads making them more attractive after the Fed’s rate hikes this year, he said. Investors can get high, single-digit yields from asset classes like high yield bonds and emerging-markets debt, he said, but “more importantly” they can get 4.5% to 5% in shorter-term, “really safe debt” whether it’s agency mortgages or U.S. Treasury bonds.

While the Fed was “slow to respond to the inflation early on,” the central bank eventually  pivoted this year with “one of the most aggressive periods of tightening that we’ve seen in history,” Shah said. The Fed raised its benchmark rate from zero to around 4% in a “very short” period of time this year, he said, while the accompanying tightening of financial conditions has been prompting concerns that a U.S. recession may be coming. 

Meanwhile, interest income from bonds can position investors to re-invest in whatever assets may be cheaper, whether its stocks or bonds, according to Shah. 

That’s the “buffeting power” of the 60/40 portfolio, he said, even if it doesn’t return to the past “goldilocks” regime in which the Fed was accommodating markets through quantitative easing. 

While the Fed’s tightening of monetary policy is going to lead to an economic slowdown, a recession is still up for debate, in his view.

Massive fiscal and monetary stimulus during the COVID-19 pandemic helped individuals, companies and markets get through the pandemic, but the replenished balance sheets also have made it “a lot tougher for the Fed to slow things down,” Shah said. 

Meanwhile, the potential for the Fed to slow its monetary tightening with smaller rate increases amid signs of cooling inflation is creating a “macro squeeze,” according to Shah. “A lot of positioning is getting challenged,” he said, explaining that many trades that have worked so far in 2022 are now going to stop working over a shorter time period.

Trends this year such as higher interest rates, a stronger dollar, and lower prices for risk assets have made it “very easy” for momentum strategies to play out well, according to Shah. But markets are now facing a stretch where the Fed may begin to slow its pace of rate hikes, so those trends won’t be as  “apparent and easy to trade,” he cautioned. 

“You will get overshoots” on individual stocks and at the “aggregate level” of the equities markets, he said. Shah anticipates markets are going to be in a period with “a chop back and forth,” cautioning that whether it’s stock or bonds, investors shouldn’t assume that the start of a positive trend is going to extend itself.

The yield on the 10-year Treasury note

has jumped this year, trading around 3.8% Tuesday morning, FactSet data show, at last check. That compares with about 1.5% at the end of last year, according to Dow Jones Market Data. Two-year Treasury yields

have also soared in 2022, trading around 4.35% Tuesday morning.

Signs of easing inflation in October, based on last week’s consumer price index report, resulted in a drop in Treasury yields. Investors began pricing in a higher probability of the Federal Reserve reducing the size of its next interest rate hike in December to 50 basis points.

On Tuesday morning, a reading from the producer price index, which is a gauge of wholesale inflation in the U.S., was also softer than anticipated.

See: Wholesale prices rise slowly again in October and point to softening U.S. inflation

The U.S. stock market remains in a bear market this year, with the S&P 500 index

down around 17% through Monday. The blue-chip index Dow Jones Industrial Average

was off 7.7% over the same period, while the technology-heavy Nasdaq Composite tumbled 28.4%.

U.S. stock index futures rose Tuesday morning on the back of the producer-price-index data. All three major indexes opened higher, with the Dow trading up 0.9% around midmorning, while the S&P 500 rose 1.6% and the Nasdaq jumped 2.4%, FactSet data show, at last check.

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