What Got You Here… Will Break You Now

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• The 60/40 portfolio that worked for decades isn't holding up in today's environment of rising inflation and higher interest rates.
• Inflation today is being driven by policy choices like tariffs and labor restrictions, not just short-term supply issues.
• To stay ahead, investors need to look beyond traditional assets and consider things like gold, commodities, and flexible macro strategies.

For decades, the 60/40 portfolio felt like the closest thing investing had to gravity. It didn’t require genius or perfect timing. You just followed the math: 60% stocks for growth, 40% bonds for safety and income. Rinse and repeat. The returns compounded quietly, and risk felt (for the most part) contained.

But what if that model wasn’t timeless? What if it was a product of a very specific era, an era that’s now behind us? We may be entering a world where the rules are different. Not temporarily different, but structurally different.

A World Built on Declining Rates Is Not the World We’re In

From 1981 to 2020, the U.S. 10-year Treasury yield fell from over 15% to under 1%. That decline supported stock valuations and bond prices simultaneously. It also allowed governments and consumers to borrow freely without feeling much pain. That era also gave us the golden age of passive investing where index funds became the default and risk-parity portfolios flourished. Discounted cash flow models looked better every year. Rising asset prices were baked into the system’s DNA.

But now we might be on the other side of that curve.

Today, the 10-year hovers around 4.5%. Sticky inflation, rising deficits, and geopolitical uncertainty have changed the calculus. Even if inflation “comes down” and “stays down,” it likely settles around 3% to 3.5%, not the 1.5%-2% investors got used to. This is more than an economic shift and more of a psychological one. Investors raised in a falling-rate world are still applying the old rules to a new game.

Inflation Is Policy-Driven, Not a Temporary Mistake

The most important insight from today’s macro thinkers is this: inflation isn’t just a byproduct of supply chains or commodity shocks. It’s the direct result of political choices.

We are raising tariffs, reshoring supply chains, and restricting immigration. These are not cyclical accidents. They are intentional moves. While they may serve long-term strategic goals, including revitalizing domestic industry, protecting labor, they come with short-term consequences: Higher prices, tighter labor, slower productivity growth.

And critically, these consequences last longer than most investors expect. You can’t just cut rates and expect prices to normalize when the inflation is arguably being created on purpose.

Take the recent tariff package as an example. A 20% effective tax on imports is a big deal, roughly a 2% hit to GDP. That filters through the economy slowly, but unmistakably, because prices rise and input costs go up. Domestic manufacturers pay more, hire more, and pass the pressure to consumers. But that’s not all. These policies also tighten the labor market.

There’s a Labor Shortage, and It’s Being Engineered

Since 2022, the U.S. labor force has stopped growing. Immigration has fallen dramatically. Visa programs have been scaled back or canceled altogether. Even recent court rulings have removed hundreds of thousands of legal workers from the U.S. economy.

This is basically a math problem: Fewer workers mean more wage pressure, and in a services-driven economy, higher wages translate directly into higher inflation or lower profits, often both.

What makes this moment so tricky is that it doesn’t look like a crisis. The economy is still growing, and jobs are still being created. But the underlying dynamics are shifting. Historically, this is exactly the type of environment where the 60/40 portfolio struggles.

Why Stocks and Bonds Might Fail Together

The magic of the 60/40 was built on negative correlation. Stocks would fall in a recession, and bonds would rally. Stocks would boom in good times, and bonds would offer a steady yield in the background. That correlation has now turned positive. In 2022, both stocks and bonds lost double digits. With broad stock market benchmarks down 19% for the year and bonds down 13%, a 60/40 mix of the two suffered its worst performance since the global financial crisis in 2008. That wasn’t supposed to happen.

But it did, mainly because both sides of the portfolio are now exposed to the same threat: inflation. Higher inflation reduces the real return of bonds. It also pushes interest rates higher, which compresses stock valuations. And if wage growth pressures margins, even earnings aren’t a safe haven. In other words, you can grow the economy and still lose money as an investor. It’s happened before.

From 1968 to 1982, U.S. GDP grew steadily. But inflation stayed high, interest rates climbed, and equities entered a 14-year bear market in real terms. Bondholders fared worse. That era looks increasingly familiar.

Diversification Isn’t What You Think It Is

Most institutional portfolios today aren’t merely 60/40. They’re 60/40 plus a handful of “alternatives” like private equity, venture capital, and private credit, among others.  But some argue those aren’t diversifiers. They’re different wrappers for the same equity and credit risk.

Private equity? Leveraged public equity with a valuation lag. Private credit? Corporate bonds with illiquidity risk. Venture capital? High-volatility tech exposure. In a downturn, these assets probably won’t hedge your portfolio. They just reprice more slowly.

So, what actually diversifies?

• Gold: Still one of the only assets that performs well when both stocks and bonds are under pressure. It’s liquid, it’s real, and it doesn’t require a central bank.
• Commodities: Especially industrial inputs like copper, oil, and natural gas. In a world of higher nominal growth, these benefit directly from rising demand and constrained supply.
• Macro strategies: Systematic trend-followers, global macro funds, and tactical allocators who can go long and short based on regime shifts, not just earnings forecasts. They may underperform in calm markets, but they thrive on disruption.

There’s a Reason Hedge Funds Like Citadel and Millennium Are Booming

These funds are not only about manager brilliance. It’s really a story about true diversification. When you combine 50 uncorrelated strategies, such as long/short equity, merger arbitrage, trend following, and global macro, you get something much more powerful than any single bet: You get resilient return streams.

You don’t need a billion-dollar ticket to get exposure anymore. Replicated alpha strategies and ETFs that index hedge fund styles are opening the door for advisors and retail investors. But it requires a shift in mindset, which is the biggest hurdle for most investors. 

The Future Belongs to Investors Who Adapt

The world of falling rates and rising margins is probably over for the foreseeable future. The question now is: how long will it take for investors to admit it? The good news is that the alternatives exist. But they aren’t always obvious, and they don’t always look pretty on a backtest. And they may not outperform in bull markets.

But when the music stops, and in many ways, it already has, they’ll be the difference between staying afloat and sinking. The old playbook was simple: buy the index, hold some bonds, don’t touch anything weird. The new playbook is far more nuanced. But it’s also more honest. It acknowledges that the future might not look like the past, and it prepares accordingly.

That’s true risk management, which, right now, might be the most important trade you make.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up for our Newsletter or subscribe on your preferred podcast platform so that you don't miss out on future episodes.