Summer of '69 Has Lessons for Investors and They Are Not Bullish

(Bloomberg) -- Rocker Bryan Adams might have had the best days of his life in 1969, but it wasn’t a great year for U.S. investors. And lessons from back then could help fund managers think through the implications of rising inflation expectations and bond yields.

The late sixties was when late-cycle fiscal stimulus contributed to runaway inflation, leading the Federal Reserve to aggressively raise interest rates, which was followed by an inverted yield curve and a recession, according to BlackRock Inc. Echoes of that year exist today, and what was notable then is that both stocks and bonds dropped, the money manager said.

“As growth faltered in 1969, bonds suffered losses even as stocks stumbled,” the firm’s chief fixed-income strategist Jeffrey Rosenberg wrote in a recent note. “What made this episode special was the combination of a recession with a structural rise in inflation expectations, challenging bonds’ ability to cushion against the downturn.”

Going back to the Great Depression, there were only three years where U.S. stocks and 10-year Treasuries both saw negative total returns, according to BlackRock’s analysis. The first was when a currency crisis forced Britain to abandon the gold standard, the second was the U.S. entry into the Second World War. The third was in 1969.

Although inflation was rising much more sharply then, a number of parallels exist between that era and today, according to Rosenberg. The unemployment rate had fallen below 4 percent and the late-cycle economy was receiving a “hefty boost” from fiscal stimulus. A Fed shift from an inflation-creating mode to an inflation-fighting mode helped contribute to a downturn in both markets, he said.

Tail Risk

Cut to 2018, when Treasury yields have climbed to the highest in seven years amid mounting concerns about inflation and the pace of Fed rate hikes. The threat of a hawkish central bank policy error beat concerns over a trade war as the biggest tail risk to financial markets, according to the latest survey of fund managers from Bank of America Merrill Lynch.

The Bloomberg Barclays U.S. Treasury Total Return Index has fallen almost 3 percent this year, while the S&P 500 Total Return Index is up by about the same amount. However, the stock gauge remains about 5 percent off its January high.

BlackRock doesn’t see any imminent warning signs of recession. And it said there is a lower likelihood of inflation rising sharply enough to prompt the Fed to invert the yield curve. Still, history shows that how a cycle ends is important to investors in determining their exposure to various asset classes, and the firm has an overall preference for stocks over bonds.

“Bonds are a good offset to stocks when it matters most, unless the equity market selloff is triggered by a Fed trying to quell runaway inflation,” said Rosenberg. “Put differently, bonds cushion against growth risks but not inflation risks.”

©2018 Bloomberg L.P.

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