(Bloomberg Opinion) — The post-election stock market is already giving investors a wild ride. Huge individual stock selloffs, massive rallies and a dizzying array of market stories built on Wall Street's best efforts to read the mind of President-elect Donald Trump. Still, the S&P 500 is up about 3% since Election Day, but the numbers don't do justice to the lackluster sentiment surrounding it. This combination of policy uncertainty with some of the highest valuations since 2021 could spur renewed interest in risk management strategies. Fortunately, there is an easy one available to everyone.
Before trying to Trump-proof any portfolio, investors should ask themselves a few key questions. First, can you keep your political biases in check? If not, you probably need to adjust your risk exposure. With Trump, you either love the guy or you hate him, and investors are at their best when they're at their most dispassionate. I worry that a toxic mix of politics and market volatility could lead people to do something stupid like sell at the bottom of the market. Or go all-in at the top. One of the most important aspects of a sound investment strategy is finding a way to sleep at night so you can stay invested in the end.
Second, do you have the skills to see into a Trump-dominated market? Even in the pre-Trump era, many investors would have told you that political forecasting was not their core competency. But Trump is a uniquely unpredictable politician who takes office with a potentially paradigm-shattering agenda and the guts of a lame duck. Is his word for universal tariffs 10%-20%; 60% duties to China; and mass deportations a negotiating tactic? An opening salvo? Or is it reckless and unbridled enough to implement them at scale against the backdrop of already elevated inflation and high interest rates? And to what extent will his cabinet, members of Congress, the judicial branch and the financial markets manage to control any excesses? Some people might think they have a legitimate “edge” to answer these questions, but I haven't come across many that I'd bet on.
If the choices make you jumpy and disoriented, the easiest solution might be a version of the classic 60/40 stock and bond portfolio. Traditional stock-bond portfolios have taken a bad turn since the punishing sell-off of the 2022 dual asset class, but those were very different times. At the time, bonds offered very little income to cushion the blow, and they were essentially moving in lockstep with stocks. Today, stock-bond correlations are turning negative again.
And yields are near their highest level since the financial crisis. Bonds now pay investors much more, even as stock yields have become increasingly sharp. High valuations are never reason in themselves to expect a correction, but they certainly have a habit of Withdrawals more painful.
In the last one ANALYSIS by Erin Browne and Emmanuel Sharef of Pacific Investment Management Co., portfolio managers showed that 60/40 portfolios rarely produce significantly negative monthly returns in periods of negative stock-bond correlation. Large 60/40 “left tails” are more common in periods of positive correlation.
Another popular criticism of the 60/40 portfolio is that it amounts to “diorsification.” Over the long term, the diversified basket of U.S. large-cap stocks is sure to rise, squeezing bond returns, so why not just stay in stocks, especially if you're young enough to expect periods of short-term volatility? This is quite true and explains why some investors gave up on bonds even before the Covid-19 pandemic. Zero interest rate policy from 2008-2015 – and then again from 2020-2022 – turned bonds into extremely low-reward assets and made stocks look irresistible. Since 2007, the S&P 500 has delivered 461% returns (at the time of writing), compared to just 59% returns for the Bloomberg US Aggregate Index, which includes Treasuries, investment-grade corporates and equity-backed securities. agencies mortgages.
There are good reasons to think that the disparity in stock-bond returns will not be as strong in the period ahead. A blur REPORT Strategists at Goldman Sachs Group Inc., including David Kostin, posited that the S&P 500 could post an annualized total return of just 3% over the next decade, with a 72% chance the index will underperform Treasuries. The poor forecast resulted mainly from extremely high initial valuations and market concentration. It seems like an extreme prediction. I'm still bullish on US stocks over the long term, but clearly the starting point matters a lot for any investment, and stocks are expensive.
To be clear, bonds are far from a perfect hedge. They would be powerless against a period of stagflation and limit your total growth if 2025 ends up being one of the Trump administration's best market years. It's also counterintuitive to buy more of them, given that one of the biggest economic risks from Trump 2.0 is resurgent inflation. But that risk is probably better priced in fixed-income securities than stocks, and — as Pimco points out — an allocation to inflation-linked bonds can provide an additional source of protection.
Furthermore, bonds are no more a flawed hedge than other options available to us, including some that are too volatile or complex for many investors. What about a “defensive put” strategy (using out-of-the-money options to insure against large drawdowns while maintaining broad equity exposure)? This is expensive in the long run and works best in sudden crashes like Black Monday of 1987, not in slow-burning markets like the dot-com bust. What about gold and Bitcoin? Sure, but some would argue they're even more frothy than large-cap stocks.
I've even considered trying to build a custom index that excludes all trades exposed by Trump, but the tentacles of the proposed agenda seem to reach into every sector of the index. You will have to exclude any company dependent on imported products; any company with widespread exports; pharmaceutical companies profiting from vaccines; green economy firms — the list goes on.
If the policy outlook has you rushing for bonds, this approach may be opportunistic. It's conceivable that the new Trump administration will try to deliver its most worrisome economic proposals out of the gate in 2025. That will give investors some concrete details to work with, rather than trying to deify the thought process. of Trump. In a best-case scenario, patient investors may even stumble upon opportunities to buy shares at more attainable valuations late next year. At worst, they will be underexposed to a rally, but have avoided a mountain of anxiety. Personally, this seems like a good compromise.
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