Pandemic portfolio for US Investors (part 1)

US is entering into a new paradigm for investing. This new paradigm is defined by (1) continuing low rates, (2) augmented by significant money printing by the Fed and (3) a potentially painful long recovery post pandemic.

The last decade for US investors has been stellar. Going forward, however, the expected returns for the standard 60/40 portfolio may be lower. Stocks, while buoyed by liquidity injections, are at a high P/E ratio. The decades old bond market has reached its zero yield (soft) limits. US still appears to be one of the safest haven market – which has supported the USD, US stocks and US bonds. Liquidity injection and an indiscriminate financial asset buying by the Fed has further driven the market up.

This sets up the stage for the next decade or so. Here are a few thoughts about some key trends that might drive the potential direction of key asset classes:

  • Nominal bonds might not be as useful in the long term given the yields are already pretty low.
  • Money printing by the Fed and a drive towards universal basic income will eventually lead to a decline in the USD as has happened during earlier deleveraging in 1933
  • Inflation may result in the next few years driven by dollar devaluation, supply shocks and move to de-globalization. However, hyper-inflation may not be an expected scenario for the US, given the debts are denominated in USD.
  • While the valuation of equities is high, it still has a much higher return expectation (E/P) vs. alternate asset classes. As a result, while equities may appear to be overvalued, there may still be room for it to go up
  • Gap between high performance and fiscally prudent companies vs. highly indebted companies may grow. As a result, traditional value based investing focused on companies with a strong balance sheet and a stable income flow may finally start to make sense again.
  • Given the low rates, valuation of companies with strong growth prospects (e.g., tech companies) may become much higher. However, given the sensitivity of valuation on discount rates and the long duration of cash flows – the valuation will be expected to be highly volatile

Given all these drivers, it may make sense to think about how the 60/40 portfolio should be adjusted in this new paradigm. I will address it in the next part of this blog.

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