Wall Street’s bulls are starting to admit the earnings bubble is real — and the 60/40 portfolio may be the first casualty

For over four decades, Wall Street's investment philosophy rested on two core assumptions. First, a portfolio composed of 60% stocks and 40% bonds would provide stability during market downturns. Second, a select group of dominant technology companies would continue to experience exponential growth, regardless of valuation. However, recent events indicate that these assumptions are being challenged.

Goldman Sachs, known for its consistently bullish outlook, published a note this week acknowledging that while there may not be a clear valuation bubble in the technology sector, there could be an earnings bubble. This follows a similar warning from Apollo chief economist Torsten Slok, who stated that the traditional 60/40 portfolio is no longer effective.

The slowdown in the AI trade and rising government debt, which is projected to reach 175% of GDP, are cited as reasons why neither the 60% nor the 40% component of the portfolio can effectively protect investors anymore.

The recent earnings reports from major tech firms have been volatile, with significant fluctuations both up and down. Analysts are debating whether these swings reflect the true impact of the AI moat or a more general sense of "financial nihilism." Microsoft, for instance, experienced a 17% stock surge, marking its largest single-day market capitalization increase since the financial crisis of 2008.

The traditional 60/40 portfolio, which has been the standard for decades, is seen as broken by some experts. Its theoretical basis was established in Harry Markowitz's 1952 work on portfolio theory, but it became institutional orthodoxy during the long period of falling interest rates beginning in the early 1980s. This period, often referred to as the "golden age" of investing, allowed bonds to serve dual purposes as both income sources and a stabilizing force against equities.

However, Torsten Slok has been warning about a potential shift since at least 2023. He predicted a rise in interest rates higher than what most consensus analysts expected. His most recent argument in August 2023 suggested that the real risk lies if the AI trade reverses or if markets become more concerned about government deficits. This multi-year thesis was not a new development, but rather a continuation of his previous warnings.

Goldman Sachs' analysis also points to a structural change in the market. The equal-weighted S&P 500 has outperformed the market-cap-weighted index by more than 7.3% for the first time since 2009. This suggests a broader participation in the market, driven by improving economies, increased M&A activity, and a decline in the momentum of recent weeks. The capital expenditure among hyperscalers has eroded the premium cash flows they once commanded, leading to a normalization of valuations.

Two months prior to Goldman Sachs' note, warnings about the potential bubble were coming from outside the big banks. Owen Lamont from Acadian Asset Management cautioned that expected long-term S&P 500 earnings growth had reached 20.2%, a level not seen since 1999. JPMorgan CEO Jamie Dimon expressed concerns about the high optimism and exuberance in the market, reminiscent of previous periods of financial bubbles that ended in downturns.

Ray Dalio went even further, drawing parallels between the current market conditions and those in 2000 and 1929, indicating a potential bubble similar in nature to those historical events.