Investors in today’s stock market face challenges previous generations haven’t had to focus on. Structurally high inflation is a great example. This trend is one that hasn’t been seen in roughly four decades (some baby boomers may remember these factors when they were younger, but as time goes by, these things become a distant memory).
Thus, while we’re living in a time of historically high valuations across the board (mirroring the dot-com bubble), housing prices much higher than the 2008 GFC levels that flattened the market for years, and bond yields which are the highest they’ve been in some time, it’s a very odd time to be an investor.
These factors, along with pervasive trade and geopolitical risks picking up, suggest to me that those nearing retirement (and even younger investors) can benefit from a strategic focus on capital preservation over portfolio growth right now. Here are a few reasons why.
Inflation Is No Longer a Rounding Error
Inflation visual
Following the Great Financial Crisis in the late-aughts, inflation tended to remain very low (at or below the 2% range) all the way up essentially until the pandemic. In fact, during specific periods immediately following the GFC, the inflation rate in the U.S. was actually negative.
In such a period of time, staying investing and sitting tight in equities and other assets made sense. For those who were able to do so, holding onto one’s house and investing in stocks at rock-bottom levels turned out to be the right thing to do. I know many personal stories of bone heads I followed during this period of time that pulled everything out of the market, only to miss out on the biggest up days in the market in decades. Though these individuals got back into the market eventually, their returns did not match those of most investors who did nothing.
In this environment, I think the traditional 60/40 portfolio may not work as it once was. As higher inflation eats into investor returns, more investors will look for higher-growth assets, which will drive more capital toward equities at least in the near- to medium-term. That is, if and until something major happens.
A Breakdown of Classic Diversification
A person looking at a diversified portfolio on a tablet
I think the dynamic I described above, in which investors in a number of high-quality equities both stay invested, and add funds to their portfolios over time, has already materialized. Indeed, bonds and other less-correlated asset classes have been tapped less by investors in recent years. Given the fact that investors who have been “all in” on stocks over the better part of the past two decades have won has likely led to such a view.
Additionally, the fact that both equities and bonds have moved in lockstep for much of the recent past has some investors concerned. If stocks go up when bond yields decline (and vice versa), does that mean that the era of negative correlation between the two asset classes is over? Coupled with president Trump’s threats around Greenland and a “Sell America” narrative brewing, that’s concerning, to say the least.
I’m of the view that if we do see significant recessionary forces take hold that we’ll see bonds and equities diverge in terms of performance once again. I just don’t think most in the market will like it. But that’s what capital preservation is about – at least with U.S. government bonds, investors know that their capital and income will be protected over time.
Aging and Demographic Shifts
Elderly couple thinking
I think the other reality that could become apparent to some investors in the decades to come is that most of the wealth is concentrated among the wealthier cohorts in society. Right now, that means baby boomers, who still have a strangle hold on the majority of wealth in the U.S. despite not being the majority in terms of the total demographic out there.
As baby boomers age, I’d expect to see a more significant percentage of assets flow out of stocks and into fixed income, equities and alternative assets as a way to build passive income and retire happily. Doing so won’t benefit younger investors, but could provide ballast to those who put some significant percentage of their holdings into fixed income options.
Personally, I’m still a proponent of the 60/40 portfolio, though my portfolio currently looks more like 60% bonds and 40% equities. I’m an inherent pessimist, which hasn’t served me well in recent years, but could do the trick in the years to come if we do see the volatility I expect on the horizon.
Top Gaining Stocks
Top Losing Stocks