Morgan Stanley’s Chief Investment Officer, Mike Wilson, proposes a shift from the traditional 60/40 portfolio to a 60/20/20 allocation. This strategy includes 20% in equities, 20% in bonds, and 20% in gold, aiming to enhance inflation protection.
New Approach to Hedge Risks
Wilson suggests that this new approach accommodates limited growth potential in U.S. stocks compared to Treasuries. It also addresses the demand for higher long-term bond yields. He sees gold as a resilient hedge that works alongside high-quality equities.
The traditional 60/40 model relies on stocks and bonds balancing each other, while gold introduces a new defensive element. Wilson prefers shorter-term Treasuries, specifically five-year notes, for capturing better rolling returns.
According to Wilson, both gold and equities serve as hedges: equities provide growth potential, and gold acts as a haven when real interest rates decrease. His perspective emerges as U.S. equities recover; the S&P 500 and Nasdaq reach new highs despite September’s weaker historical trends, influenced by Trump’s tariffs announcement on April 2.
With the S&P 500 and Nasdaq pushing fresh highs, we should look at strategies reflecting limited upside from here. We can use derivatives to sell out-of-the-money call options against current holdings, generating income while the market possibly trades sideways. This is especially attractive as the VIX, a measure of market volatility, has fallen to 13.5, a low not seen since the fourth quarter of 2023, making option premiums appealing for sellers.
Gold as an Effective Hedge
We should now treat gold as the more effective hedge, especially with inflation concerns persisting. We’ve seen historically that gold has a strong inverse correlation to real interest rates; a 1% decline in real yields has often corresponded with a high single-digit percentage gain in gold. Therefore, buying call options on major gold ETFs provides leveraged exposure to any flight to safety or drop in real rates.
The preference for shorter-term bonds means we should adjust our positions on the yield curve. A practical way to implement this is through Treasury futures, perhaps by favoring long positions in 5-year note futures over 10-year note futures. The spread between the 5-year and 10-year yield has recently narrowed to just 15 basis points, making a curve-steepening trade a compelling way to capture potential shifts in rate expectations.
This cautious stance is reinforced by the calendar, as we are now in the middle of a historically weak month for stocks. Since 1950, September has been the worst-performing month for the S&P 500, with an average decline of roughly 1%. This seasonal headwind provides another reason to buy protective puts and build up hedges in assets like gold for the coming weeks.
