![]() ![]() The portfolio construction is predicated on the theory that stocks and bonds are inversely correlated- when one is up, the other is flat or even slightly down- so the portfolio automatically hedges itself. Most advisors will tell you this portfolio is bulletproof, it has rarely had down years, and it is a “set and forget” method to steadily build wealth passively. This is the most common portfolio recommended to Baby Boomers (who hold the vast majority of US wealth), and is taught to financial advisors by firms such as Northwestern Mutual, Vanguard, Fidelity, Goldman, and many others. This matters because the bedrock of American financial planning is the 60/40 risk parity portfolio- 60% stocks, 40% bonds. ![]() bond funds witnessed outflows worth a net $8.81 billion, the most in a week since June 22.”įurthermore, Emerging Markets were hit hard as well- according to the WSJ, investors pulled $108 million from EM bond funds last week, on resurging concerns that the strong dollar and the Fed aggressively tightening can put emerging markets under further pressure. bond funds in the week to Aug 24 as they waited to hear a speech by Federal Reserve Chair Jerome Powell later on Friday which will be scrutinised for clues on the pace of forthcoming interest rate hikes. This last Friday, August 26th, bond funds experienced their biggest outflows in 8 weeks. Let’s take a look at the Bloomberg Aggregate Bond index (AGG): This will have disastrous implications for the American economy at large. The Fed is currently intent on fighting record inflation by crushing bondholders, including holders of US Treasuries and Corporate Debt. However, in an economy as indebted as ours, a slight increase in interest rates can mean catastrophic increases in interest expenses in the financial system- especially for over indebted companies, right as their net margins are squeezed by inflation. The problem is, this will certainly cause a recession (actually it already has, Q1 GDP printed -1.6%, and Q2 came in at -0.9%). Normally, a recession is in many ways a good thing leveraged businesses and unhealthy enterprises are cleaned out of the system, temporary pain is inflicted on the economy, but this lays the groundwork for new firms to rise out of the ashes. Since the Fed cannot increase the supply of commodities in any meaningful way, the only way they can broadly effect prices downwards is demand-side, meaning to fight inflation they must “destroy” demand by making it prohibitively expensive to borrow, crushing equity markets, and eliminating the much vaunted “wealth effect” that they claim rescued the US economy from the depths of 2008. In the world of economics, there are two general factors that affect prices broadly: supply and demand. ![]()
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