A balanced portfolio that once saw double-digit returns likely won’t when the Federal Reserve tightens and normalizes monetary policy.
In the past six and a half years, investors have experienced what Lisa Shalett, head of investment & portfolio strategies for Morgan Stanley Wealth Management, calls “this nirvana period of free lunch.”
“Over the last six and half years, the S&P 500 has compounded at roughly 15% [and] at the same time the U.S. bond market has compounded at 9%,” she explained during a press briefing last week in New York. “Now typically stocks and bonds are negatively correlated, right? One of the outgrowths of quantitative easing is that they were positively correlated. So if you had a balanced portfolio of stocks and bonds, you experienced superior returns, and that portfolio has returned double digits.”
The Fed resisted moving at its last meeting, but what happens when policy begins to normalize and when the Fed in fact begins to tighten?
“Our outlook is that the balanced portfolio that delivered those double-digit returns probably over the next 5-7 years is going to return something a lot closer to 4%-6%,” Shalett said, adding, “those 4-6% returns are pretty decent. They’re OK, but they’re not going to be the double digits that we’ve seen over the past six years.”
Shalett shared the advice she’s currently giving wealth management clients on how to position their portfolios in preparation of the Fed tightening policy:
1. Globalize Portfolios
“The first piece of advice that we press hard on is this idea of globalizing your portfolios,” Shalett said.
This can be a challenge for clients, who tend to be U.S. citizens and have a U.S. bias.
“One of the challenges that we have … is opening their mind to the opportunities,” she said, including “places like Europe and places like Japan, in addition to the United States.”
2. Manage Volatility With Alts
Because quantitative easing and zero interest rates caused overall volatility in markets to come down, Shalett said that it’s going to feel “way more volatile” as policy begins to readjust.
“Now is the time to rethink ‘How do you manage volatility?’” Shalett said. “Now historically – certainly prior to the crisis – one way you managed volatility was with bonds [and] they will continue to play that role.”
But, she added, the problem with using bonds is that the Fed has a tightening bias.