Economists are warning that a resurgence of inflation, coupled with rising unemployment, could undermine traditional investment strategies. This economic environment, reminiscent of the 1970s, threatens to disrupt the conventional wisdom of portfolio diversification, specifically the 60/40 portfolio, which allocates 60 per cent to stocks and 40 per cent to bonds. National Australia Bank’s chief economist, Sally Auld, suggests that supply chain shocks, including trade barriers, climate change, and geopolitical conflicts, are fuelling a ‘regime change’ that challenges this once-reliable approach.
Traditionally, a spike in unemployment would trigger a sharemarket sell-off, boosting demand for bonds as central banks cut interest rates. However, in a stagflation scenario, where high unemployment coincides with high inflation, both bonds and equities struggle, exposing 60/40 portfolios to significant losses. Auld noted that the historical negative correlation between bonds and equities has flipped, meaning their returns are now tracking each other, potentially making the 60/40 strategy less effective.
GSFM investment advisor Stephen Miller suggests that a diversified strategy should extend beyond stocks and bonds to include assets like gold, private assets, and even a small allocation to cryptocurrency. Schroders’ head of multi-asset investments Sebastian Mullins added that the threat of higher inflation was ‘here to stay’ because of governments stimulating their economies to reduce the value of their debt. He also noted that while holding bonds alongside equities can still work, a more tactical approach is needed.
Mullins said that Australia is well-positioned to handle these risks due to its stronger fiscal position and more stable politics. He suggests that bonds still offer value but require more active management, focusing on high-quality income rather than solely relying on their diversification benefits. ‘Bonds do work, but you have to be more active,’ he said.
