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Goldman Sachs Says You May Not Want Bonds in Next Market Cycle

Goldman Sachs Says You May Not Want Bonds in Next Market Cycle

Investors may need more equities in their portfolios to generate positive returns thanks to misfiring bonds, according to Goldman Sachs Group Inc. strategists.

It might not be their base case just yet, but the strategists suggest a higher allocation to stocks and cash than the historic norm would be advisable in a world where Treasuries struggle to hedge market downturns. Strategists including Christian Mueller-Glissmann and Peter Oppenheimer even entertain a scenario where bonds prove so useless that an all-equity allocation would be preferable to balanced portfolios that invest 60% in shares and 40% in fixed income.

“In the new cycle for most investors equity allocations might have to be higher,” according to the Nov. 8 report. “Higher relative returns on cash can also drive a higher equity allocation as bonds become less attractive compared with cash –- as long as the equity risk premium is positive.” 

Goldman Sachs Says You May Not Want Bonds in Next Market Cycle

To be sure, they say it’s too early to ditch 60/40. Under their base case of steady growth and a slightly negative equity-bond correlation, the strategists see a traditional portfolio offering a “small” benefit over one with equities, cash, and no bonds.

Yet as stocks and bonds move in tandem more often, the fear is that the latter is becoming less of a reliable equity hedge -- suggesting drastic changes to allocations aren’t out of the question.

In a scenario where “equity/bond correlations are zero -- the optimal equity weight increases to 100% pointing to no benefit to holding a balanced portfolio,” the strategists wrote. 

Here are other reasons why investors may want to allocate more money to stocks going forward:

  • A positive equity risk premia
  • Bonds are getting less attractive because their yields are still low despite rising inflation; they risk returning less than cash
  • Rates volatility might be higher in the next cycle

Real yields are a caveat. Right now they’re at record lows, supporting high price tags on stocks. But a sharp reversal could point to poor equity returns. While Goldman expects real yields to rise, it reckons the pace would be gradual. 

All the same despite doubts over the 60/40 portfolio over the years, it’s delivered strong real returns since the global financial crisis. Thanks to a favorable growth/inflation mix, U.S. risk-adjusted returns were nearly three times their long-run average, according to Goldman. 

“The current generation of investors have been able to generate attractive returns without much risk,” said Mueller-Glissmann. “But going forward acceptable real returns might mean unacceptable risk.”

©2021 Bloomberg L.P.