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Time for a new approach?
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“ ‘If it were to work on a secular basis for five years, 10 years, 20 years, then we have unambiguously failed as a democracy. The reason financial markets have done well over the last 40 years is because we’ve been in a 40-year disinflationary environment.’ ”
That’s Paul McCulley, former chief economist at PIMCO, talking with Bloomberg News in a podcast posted on Thursday about the popular 60/40 strategy, a longtime winner for investors looking to cash in on market gains but also have built-in downside protection.
The approach is simple: 60% of a portfolio in stocks and 40% in bonds. The two, in the short term, at least, tend to move inversely to each other, which helps make for a smoother ride when volatility picks up. It’s had a great run, as you can see from this Bloomberg chart:
However, McCulley, on the “Odd Lots” podcast, warned that it’s a troubling trend.
“Unambiguously, we’ve had 40 years of disinflation, and that’s because we’ve shifted power in our economy, both domestically and globally, from labor to capital,” he said. “It’s been an incredible bull run on the valuation of financial assets. And I certainly hope, as a citizen, that is not repeated.”
McCulley, who’s been around Wall Street long enough to coin the phrases, “shadow banking” and “Minsky moment,” explained to Bloomberg News that, decades ago, policies were put in place that created a “monetary policy dominant world,” which ultimately succeeded in crushing inflation, but at the expense of full employment and other economic priorities.
“I really hope that my old profession figures out a new paradigm,” said McCulley, who left his money-manager profession and is now a faculty member at Georgetown law. “What’s worked the last 40 years should not work unless you want democracy to fail.”
He warned that those very policies are now due for a shake-up, and when that happens, the portfolio constructions that have worked in the past, like the 60/40, will no longer provide the kinds of returns investors have grown accustomed to over the past 40 years.
Meanwhile, the stock market took big breather in Thursday’s trading session, with the Dow Jones Industrial Average DJIA, -2.75%, S&P 500 SPX, -3.57% and Nasdaq Composite COMP, -4.99% all firmly in red territory.
