Posthaste: How the collapse of the 60/40 portfolio has made the world a more dangerous place
For years investors relied on a mix of stocks and bonds to manage risk in their portfolios, but times have changed.
The classic diversification of 60 per cent stocks and 40 per cent bonds worked historically because they moved in opposite directions. When stocks fell, bonds rallied, cushioning losses.
But now instead of offsetting equity risk, bonds are increasingly moving in tandem with stocks, raising red flags at the International Monetary Fund.
“This shift is particularly pronounced during sharp market selloffs, with profound implications for investors and policymakers alike,” said IMF authors Tobias Adrian, Johannes Kramer and Sheheryar Malik in a recent post.
The IMF tracks the turning point for correlations between stocks and bonds to around the end of 2019. During the pandemic as inflation soared, the historical relationship shifted “significantly” with stocks and bonds selling off simultaneously more often.
Today symptoms of the breakdown can be seen in the increased severity of recent market selloffs — “losses compound when both assets fall together” — and in skyrocketing gold and precious metal prices , as investors seek alternative safe havens.
It has increased risk for the leveraged strategies of hedge funds and even more conservative institutional investors like pension funds and insurers.
“If diversification fails, volatility can cascade into broader financial instability,” said the IMF authors.
“Investors and policymakers must rethink risk management for a new era where traditional hedges fail.”
Concerns about bonds have grown over the past few years as supply swelled in most advanced economies looking to finance growing fiscal deficits. Above-target inflation heightened the risk.
The IMF said central banks could intervene to stabilize bond markets if extreme stress emerged, but there are limits. Such emergency measures can create a moral hazard which encourages excessive risk taking.
What is really needed to restore the hedging properties of government securities is fiscal discipline among nations with high debt levels, it said.
“Without credible fiscal frameworks, bonds cannot serve as reliable anchors in turbulent markets.”
Central banks can help by maintaining price stability, as the pandemic’s inflation shock was a key contributor to the reversal of the stock-bond correlations. Regulators also need to incorporate the breakdown into their stress tests.
“Financial institutions need to prepare for traditional diversification to fail, as models calibrated on historical correlations may underestimate new risks,” said the IMF.
Investors too should rethink risk and build portfolios that take the shift in correlations into account, but that can get tricky.
“Alternative strategies — such as incorporating commodities or private assets — may offer partial solutions, but they come with their own complexities and risks,” said the authors.
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Millennials are pulling the plug on electric vehicles.
Demand for EVs, in general, has ebbed over the past few years as gas prices fell and government subsidies expired, but, according to data compiled by Bank of America, it is especially evident among millennials.
The bank looked at auto loan originations and found that over the past two years, millennials have pulled back from EVs more than any other generation. While the data is U.S., the same conditions existed in Canada: cheaper fuel and fewer subsidies.
“Given that this group may be acutely feeling affordability pressures around housing, childcare and costs of living, it’s not too surprising that they are less inclined to take on the often-sizeable upfront payment required to buy an electric car,” said Bank of America.
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McLister on mortgages
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Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.
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