Following up on yesterday’s thread: Why would anyone bother buying bonds now? Traditionally, the 60/40 paradigm offered diversification and insurance, peace of mind. But what lies ahead? Take a look at this chart and we'll dive in. (THREAD)
As the chart shows, the only other time the 5-year inflation rate crossed above the nominal yield was 1942. That spurred a long period of very low nominal returns and negative real returns. The 20-year forward real return (yellow line) was negative for almost three decades. /2
The correlation between stocks and bonds back then was positive, from the 1930s all the way to the '50s. In other words, with perfect hindsight, there was absolutely no reason to follow any kind of 60/40 model back then. /3
Nominal returns were near zero, real returns were negative, and bonds offered no downside protection from drawdowns in the stock market. /4
While nominal yields (and therefore forward returns) are equally low now, and real returns are likely to remain negative for years to come, the one saving grace for the 40 side of the 60/40 model is that bond returns continue to be negatively correlated to equities. /5
But (as the next chart shows) if the current inflation regime proves to be structural rather than transitory, it’s plausible that this correlation could flip from negative to positive. /6
The chart shows the 10-year inflation rate on the horizontal axis and the 5-year correlation between the S&P 500 and the Barclays Long-term Government Bond Index. The further inflation moves above its long-term average (about 3%), the more positive the correlation. /7
The historical analog for the switch from negative to positive is the mid-1960s. After about a decade of negative correlations, in 1960 the 5-year correlation bottomed at -36%, and in 1965 it flipped positive. /8
While the correlation remains negative today at -29%, the extreme was registered in 2015. So that would put us around 1966 if the analog holds. /9
As the next chart shows, we seem to be following the 1960s analog very closely, in terms of the long-term inflation trend (using a 5-year CAGR). /10
There are quite a few similarities between now and the second half of the '60s, from speculation in high-profile tech stocks to social unrest (during the lockdowns), to creeping inflation, to fiscal policy largesse (Guns & Butter). /11
In my next thread, we'll consider how best to diversify in the future if indeed the 60/40 model is becoming unworthy. /END

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More from @TimmerFidelity

3 Nov
Until a few years ago, investors pursuing a diversified 60/40 portfolio got decent bond yields and downside protection when stocks slumped. But if that regime comes to an end (not a prediction, but certainly a possibility), how do we diversify from here? (THREAD)
The chart above shows that during the past two inflation super-cycles (the 1940s and 1965-80), bonds offered little protection. The scatter plot shows the nominal return index for the 60/40 model on the horizontal axis, and the real return index on the vertical. /2
Indexed to this series are the real returns for long-term government bonds, cash, high yield, TIPS (using a colleague’s synthetic series), gold, silver, the CRB, and the S&P 500. /3
Read 6 tweets
2 Nov
Increasingly, investors are questioning whether the tried-and-true 60/40 paradigm is still relevant after a two decades-long reign. Those concerns may be justified. Take a look at this chart, and I'll explain. (THREAD)
Investors are reacting to the back-up in rates from their historically low levels amid persistent, high-inflation prints. The chart above shows that over the long term, forward bond returns have an inverse relationship to their current yield (or valuation). /2
The chart shows the long-term Government bond yield (using the Ibbotson SBBI series), which on average has a maturity of around 20 years (give or take). Overlaid is the 20-year forward return. /3
Read 9 tweets
28 Oct
Bitcoin briefly beat its previous all-time-high, only to reverse lower. Short-term holders (less than 3 months) account for only 15% of all bitcoins, which remains below where it has been at most bottoms. So what's going on? (THREAD)
One thing: There’s now a retail vehicle for owning bitcoin, for those investors who don’t want to have to remember their keys. It may not be perfect but it might do for now. /2
In retrospect, some sort of buy-the-rumor, sell-the-news effect was to be expected, although the on-chain dynamics continue to show no signs of a speculative extreme. /3
Read 5 tweets
26 Oct
With the Fed's taper imminent, rates were on the move again last week, both in nominal and real terms. The TIPS break-even spread continues to test its upper bound of the past five years or so. Are inflation expectations ready to break out? (THREAD) Image
TIPS break-evens have rebounded from the depths of the pandemic. History shows a tendency to mean-revert around 2%, with the top of the range around 2.3% in recent years. But further back, break-evens spent a fair amount of time near 3%. /2 Image
Given that the CPI is north of 5%, a breakout to 3% would not surprise me. /3
Read 6 tweets
22 Oct
Bitcoin made a new all-time high of $66,000 on Wednesday. The chart below shows that both my supply and demand models continue to point to higher prices. (THREAD)
The gains have been pretty stealthy and without the help of momentum chasers. That may be ending now with the SEC approval of a futures-based ETF. /2
Whether such a development will prove to be a sell-the-news event remains to be seen, but I doubt it given the on-chain dynamics mentioned above. /3
Read 5 tweets
22 Oct
Is today's market an echo of the 1940s? The next few charts show the risk-reward tradeoff for the current cycle and for the WWII era. Look at this first one—a snapshot of the past 70 years—and I'll explain. (THREAD)
The chart above sets the stage with the baseline history. Cash at the lower left, stocks at the upper right, 60/40 in the sweet spot, and commodities in the worst place possible: earning only the inflation rate but with a massive vol. /2
Now let’s look at the past 18 months in the chart below. Commodities are up and to the right, along with equities, while bonds are well below the inflation rate. /3
Read 10 tweets

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