An ‘ugly Goldilocks’ scenario for stocks and bonds

Stable or rising interest rates could keep bond prices in a bear market, the former Bridgewater exec explained. And stocks may not be able to meet Wall Street’s lofty forecasts without some profit-juicing Fed policy. Analysts are expecting a more than 11% jump in S&P 500 earnings this year, according to FactSet data.

“I think the economy is a little too soft to meet equity investors’ expectations of earnings growth, and the economy’s a little too strong to meet bond investors’ expectations of cuts,” Elliott told Fortune. “It’s an ugly Goldilocks.”

Both the S&P 500 and tech-heavy Nasdaq Composite touched record highs this week after a cooler-than-expected inflation report lifted investors’ hopes for a September interest rate cut and an extension of the ongoing AI boom. 

But Elliott warned that an income-driven economic expansion may keep inflation above the Fed’s 2% target for some time, without providing sufficient growth for corporate earnings to rise substantially. 

“We can easily have a moderation of growth—that is meaningfully weaker than what expectations are—which is not enough to tilt the economy into recession, or necessarily solve the inflation problem,” he argued.

To his point, wages rose 8.6% in 2022 and 7% in 2023. That’s helped to boost consumer spending and keep inflation elevated. However, annual wage growth slowed to 4.1% in May. 

Still, Elliott believes too many investors are putting their hopes in friendly Fed policy, which has proven to be difficult to predict, to say the least. “We’ve been through various waves of expectations of cutting that have mostly not materialized. And you would’ve been in a lot better shape fading those expectations,” he said.

Elliott also pointed to high commodity prices as evidence that inflation may be more persistent than originally anticipated, noting that the Community Research Bureau Index, a benchmark for 19 global commodity markets, is up 17% over the past 12 months.

For investors that hold the typical 60-40 portfolio—60% stocks, 40% bonds—that means it may be time to diversify your holdings to protect against an environment with persistent inflation and low growth.

“My guess is it’s going to be a weak period for assets like stocks and bonds through the end of the year, relative to cash. And that assets like gold and diversified commodities will be valuable complements to the 60-40 portfolio,” Elliott said.