One troubling development has emerged during the recent market turbulence: Investors, seeking some place to ride out the shockwaves, increasingly have nowhere to go. Investors, who have long relied on a traditional mix of 60/40 stocks and bonds to achieve growth while managing risk, can no longer depend on bonds for protection when equities are falling. The 30-year U.S. Treasury yield briefly topped 5% this week, though it has since pulled back slightly from those levels. Bond yields and prices move in opposite directions. The U.S. dollar, a safe haven asset that typically rises during periods of market turbulence, has instead weakened after the April 2 tariff announcement fueled an exodus from U.S. assets. The U.S. dollar index, representing the value of the greenback against a basket of global currencies, has retreated sharply by more than 10% from its January highs. US30Y YTD mountain US30Y The behavior signifies a regime change in the way investors should be thinking about asset allocation, as geopolitical risks weigh on the market cycle, according to Henry H. McVey, head of global macro and asset allocation and CIO of KKR’s Balance Sheet. He was also once the chief U.S. investment strategist at Morgan Stanley. “During risk off days, government bonds are no longer fulfilling their role as the ‘shock-absorbers’ in a traditional portfolio,” wrote McVey. “As such, there is now an ongoing clear and present danger for global allocators who bought into the idea that when stocks sell off, bonds will always rally.” “While bonds and stocks were selling off together, the U.S. dollar was also weakening,” McVey continued. “As a result, there has been a growing fear that, because of dollar weakness, local currency liabilities have the potential to become a more severe drag on performance than expected, especially during turbulent days in the market.” McVey worries the slump in U.S. Treasurys and the U.S. dollar are long-term trends, especially as more investors decide to pull back from overweight positions in U.S. assets in favor of a more global diversification. While that could prove difficult to execute when it comes to the U.S. stock market, which is roughly twice the size of Europe, Japan and India combined, it could prove fruitful for fixed income, he said. “If our Regime Change thesis continues to play out the way we think it will, the traditional role of U.S. government bonds in many global portfolios will become more diminished,” McVey wrote. “The reality is that the U.S. government is burdened with a large fiscal deficit and high leverage, and its bonds are likely over-owned by many global investors who have benefitted from both positive interest rate differentials and a strong U.S. dollar.” McVey said local bonds — as in, those that are international — could give investors the diversification U.S. government bonds “might struggle to deliver.” He’s also positive on private equity, as well as infrastructure.
