Stagflation Is Coming. All-Weather?

You've probably heard or read predictions calling for a lost decade. Barron's just this weekend talked about lower returns coming. Torsten Slok from Apollo says that stagflation is coming. Will we have a lost decade? Is Slok correct about stagflation?

I have no idea whether stagflation is coming but as usual, I am more interested in if he is right, then what? Slok tells us that stocks should go down and rates should go up. Interest rates going up doesn't worry me from a portfolio perspective, I pretty much don't have any interest rate risk in the portfolio. If something somehow broke or malfunctioned though, there could be unexpected fallout in some random income market niche. That's not a prediction, more like a reiteration to diversify across many fixed income or bond proxy segments in case something crazy does happen in one pocket. If longer bonds went way up in yield, that would be something to consider, 7% for ten years is a lot more interesting than 4.4%.

What about equities going down? Over the last couple of days, I've seen a lot of opinions expressed implying the market event is over and that people worried and panicked for nothing. Panic selling is always a bad idea so that's not what I am talking about here but no one knows whether the event is over or not. Woe is me four weeks ago was just as unproductive as gloating that it's over now because no one knows. I've been talking for months about positioning to be less volatile that the market as opposed to wanting to do any meaningful selling. 

Nothing has changed for me on that front at this point but right here, right now, but anyone who felt they got caught wrongfooted a few weeks ago but managed to hold on, maybe now is a time to make changes?

The 7.2% is from the high watermark. Since April 2nd, the S&P 500 is actually up ever so slightly and YTD, the index is down 3.3%. Fortunately, I don't feel wrongfooted from the last month or couple of months or whatever but, looking forward, what if anything should we start to think about for a lost decade or stagflation? 

My first thought is to think about the all-weather attributes of Permanent Portfolio-inspired, quadrant investing. The Permanent Portfolio allocates 25% each to stocks, gold, long bonds and cash. So I don't necessarily mean copying that but maybe taking influence from the idea. If Slok is correct about rates going up, 25% in long bonds implies a lot of pain. 

2022 gives a good test for stagflation as Slok sees it because rates went up and stocks went down. Client and personal holding BLNDX bills itself as an all-weather strategy. Blending it with PRPFX could be interesting, it would only have 12.5% +/- in long bonds so it might be interesting to see if a smaller weighting would be problematic to the bottom line of the portfolio. In 2022, that blend was down 89 basis points so some drag (PRPFX did worse than BLNDX that year) but not problematic. 

Portfolio 3 is sort of close to what we blog about regularly. We had a lost decade from 2000-2009 but there were several years that stocks went up kind of lot. In 2003 the SPY ETF was up 28%, up 10% in 2004 and 15% in 2006 which is why there is a decent weighting to equities. I would expect broad commodities to get a tailwind in a stagflationary environment, they did better than gold in 2022 but maybe gold would be the better choice going forward. In the real world, a portfolio could have both. I threw in convertible arbitrage for being bond like but without interest rate risk. However that's not to say it couldn't be vulnerable to something malfunctioning. Also in the real world, I wouldn't go anywhere near 30% in one alt. 

The backtest is also useful for showing BLNDX finally struggling, it is down this year as equities and managed futures are both down. While there is something intellectually appealing about getting all done with one or two funds, it really is not a great idea. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.