Without a doubt, 2022 has been a year full of uncertainty. Since 2020 looks like we are on a roller coaster of instability that has peaked during 2022 A of this year, it looked like the historical diversification advantages of the traditional 60/40 portfolio were going to disappear as inflation began to take hold.
Few could imagine the extent to which this would materialize: equities found themselves in bear market territory at one point, while bonds experienced the biggest sell-off since 1994. But what can we expect in the future? Have valuations readjusted enough and is there enough yield on bonds for the 60% stock/40% bond mix to be appropriate again in portfolios?
“For much of the last 25 years, investors have benefited from a consistent negative consequence between equities and fixed income. In short, when equities fell, investors could rely on fixed income as a drag and protection in a multi-asset portfolio”, says Jaime Raga, senior CRM at UBS AM Iberia.
However, high inflation and the hawkish hold policies of central banks have put financial markets under significant pressure in 2022. Investors have had virtually nowhere to turn: equity total returns from a global decline 21% in the first 10 months of the year. Sovereign bonds and Global credit have also performed poorly, with total returns of -22% and -21% respectively.
This has made the normally negative consequence between stocks and bonds turn positive. As of mid-November, the year-to-date return for a portfolio weighted 60% US stocks and 40% US Treasuries is -15%. “There have only been five calendar years in which the annual return of this traditional portfolio structure has been worse and, apart from the global financial crisis of 2008, all were more than 80 years ago,” says the UBS AM expert.
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“The short-term macroeconomic outlook is unusually uncertain. However, regardless of what happens in 2023, we believe that inflation, growth and geopolitical factors, which have caused volatility in markets in 2022, are increasing the attractive opportunities for investors who are willing to mediate risks to take risks at term. Therefore, it is good news from the bad markets”, comments Raga.
From UBS AM, his base case scenario is that the five-year expected annual return for a global 60/40 portfolio is now 7.1%, up from 3.3% in July 2021, while the actual return (i.e., adjusted for the would be) inflation of 4.2% versus 1.2%. “This is the best return outlook since at least the quarter of 2018. For investors who embrace diversification and increase portfolios with additional asset classes, the expected return profile is even better,” he specifies. This would be particularly relevant in the current environment, where investors have to consider the possibility of a more inflationary macroeconomic scenario continuing for some time.
The main reason for the increased expected returns across all asset classes is improved valuations relative to those included in our mid-2021 capital market assumptions. More favorable valuations, while maintaining Similar prospects for real activity lead to higher return expectations, other things being equal.
Likewise, currencies are another key asset. The US dollar has become even more expensive in the past year, which, according to our projections, increases the expected depreciation of the dollar over time as it approaches fair value.” We believe this is poised to boost returns for dollar-based investors holding international assets over a five-year horizon,” Raga concludes.
