This Week is Proof: The 60/40 is Doomed in Years to Come

Today’s frothy market is giving 60/40 investors a bitter taste of what is to come. Record-high stock valuations, exorbitant debt, high inflation, and rising interest rates are sowing the seeds for a radically different economic era.

Key Takeaways:

  • Inflation jumped up to 7.5%, blowing away expectations yet again. In response, the stock market turned down while bond yields spiked up.
  • Every time inflation exceeded 5% in the last six decades, a recession followed shortly after. Are we headed there now?
  • The traditional 60/40 portfolio has worked well for the last 40 years, but modern portfolios need to take a look at alternatives.
  • More Inflation News? Really?

    Inflation sped past expectations…again. We are beginning to sound like a broken record. If this weren’t so terrifying for our economy, we would love to move past the inflation topic.

    The Consumer Price Index, which measures price changes of household goods and services year-over-year, came in at 7.5% today. Food, energy, cars, and housing prices are all rising at alarming rates, forcing CPI to the highest level in four decades.

    The news intensified this year’s stock and bond selloff. Bond yields, which are inversely correlated to the bond prices, jumped higher. The 10-year treasury yield jumped above 2% for the first time since 2019.

    Bond prices dropped

    S&P 500 drops on inflation news

    The 60/40 Fail

    Investors committed to the traditional 60/40 stock/bond portfolio should be alarmed at these dynamics. Bond prices and stock prices are falling simultaneously.

    Conventional wisdom tells us that bonds provide a safe haven during stocks market downturns. The 60/40 works well during a secular environment of declining interest rates and low inflation, but not so much during an extended period of higher inflation and rising interest rates.

    Today’s frothy market is giving 60/40 investors a bitter taste of the years to come. We are entering a completely altered market environment, which requires an equally radical reassessment of portfolio allocation.

    10-year yield: falling for 40 years

    Gold has a Strong February

    Gold is still consolidating inside its wedge formation. The price is up 2% so far in February. Today, the price failed to break through the upper resistance line. We will see if stock market weakness and inflation data are strong enough to trigger a large-scale move.

    Gold: strong February, but still consolidating

    We did see gold break above the key $1,834 resistance line very briefly. The price needs to stay above that level and overtake some previous highs to argue a bullish trend. U.S. dollar strength and rising real yields could slow gold’s momentum.

    Brief break above $1,834

    Are We Approaching a Recession?

    Since the 1960’s, high inflation has only meant one thing: recession. In fact, every time inflation exceeded 5% in the last 6 decades, a recession followed shortly after.

    The chart below shows U.S. recessions in green and the Consumer Price Index in blue. Do you notice a pattern?

    CPI and recessions since 1965

    Every recession is unique, but the macroeconomic patterns are remarkably consistent.

    In the years preceding a recession, the government and the Fed loosen financial conditions with low interest rates and excessive money printing. These push up inflation and cause unsustainable financial bubbles in equities and housing. Government debt soars.

    At some point, consumers and investors start getting jittery. Policymakers are forced to tighten financial conditions. The Fed raises rates to combat inflation. Throw an overvalued stock market, falling consumer confidence, and maybe an energy crisis into the mix, and you have perfect conditions for a deflationary economic disaster.

    To “save” the economy, the Fed jumps back in and drops interest rates. The government prints money to stimulate economic activity. The economy recovers, but only on the back of extremely loose economic conditions that caused the mess in the first place.

    And…the cycle continues.

    Waiting for the Trigger

    Most people can guess where we are in the cycle. Government debt recently surpassed $30 trillion. Over the last 14 years, the Federal Reserve has initiated the most accommodative monetary policy in U.S. history. To top it all off, we even have an energy crisis brewing in Europe.

    All that said, there is no need to panic – unless you live in Ukraine or Taiwan, then perhaps you should panic. Prudent investors can prepare for black swan events.

    If you are wondering how, give your Vaulted advisor a call. They can help with the financial insurance side of things.

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    As always, thank you so much for reading – and happy investing!

    Additional Resources:

    US inflation highest in 40 years, with no letup in sight (AP News)

    Dow slides 500 points as yields spike following red-hot inflation report (CNBC)

    Crop Prices Poised for Record, Signaling Further Food Price Pain (Yahoo Finance)

    The Housing Boom May Be About to Go Bust (Bloomberg)

    US warns Russia is still ramping up military activity near Ukraine (Financial Times)