Asset Class Opinions as of December 7, 2019
Bonds and Stocks
Our Global Tactical Allocation strategy is slightly overweight equities on the basis that the economy is healthy, unemployment is low, and consumer confidence is generally sound. We believe that fiscal and monetary stimulus turned positive several months ago and, given the typical lagged effect of policy changes, we would not be surprised to see the accommodative stance support the market into year end. Furthermore, an uptick in global economic surprises suggests that earnings estimates may soon move higher, particularly for cyclically sensitive groups.
Governments and Credit
With strong profits and cash flows, we expect defaults to remain very low and, therefore, expect credit spreads to flow through to returns. The yield pickup from owning investment grade bonds is attractive and interest payments are well covered by corporate cash flows. Government yields relative to inflation are not attractive at these levels.
Investment Grade and High Yield
As economic conditions have kept defaults low in 2019, high yield bonds and bank loans have performed strongly, leading to tight credit spreads. We believe the risk/return tradeoff of lower-rated bonds versus investment grade corporates is neutral at best. If economic growth were to weaken, high yield could quickly fall from favor. We have no position in high yield at this time.
Higher and Lower Rates
Interest rates look to be range bound for the time being, with the US 10-year Treasury wondering between 2.5% and 2.8%. Fed Funds rates in the mid 2% range support the lower end of this range, and falling bond yields in Europe limit the upper end given the spread between US and European markets. Inflation signals are weakening and don’t appear to be influencing rates today. We have recently added duration and favor a neutral to slightly short stance.
Weak and Strong U.S. Dollar
Strength in the U.S. dollar could reverse if we see the economy weaken, but for now our economy is strong and interest rates are high, which is appealing to foreign buyers. We do not have a strong near-term outlook for the dollar but have a mid-term bias toward some weakening to come.
Domestic and International
International equities carry a normalized P/E ratio that is just two-thirds that of the U.S. market. This valuation discount is offset by weak economic conditions in Europe; we expect U.S. earnings growth to easily outpace international results. An important historical trend to watch for is the potential for a U.S. bear market to flip investor preference from recent winners and domestic stocks into a rotation move toward international stocks. This reaction has accompanied several contemporary bear markets but has yet to appear following the 4Q18 decline. Pending such a shift, we remain slightly overweight U.S. equities based on stronger fundamentals.
Developed and Emerging
Our research suggests that, as a high-beta risk play, Emerging Markets typically fall early in a down-cycle but then lead Developed Markets off the bottom. We also believe EM is one of the best plays on a weaker U.S. dollar. As the largest Emerging Market country, China’s growth rate and a resolution of trade issues are important drivers for EM gains. We have increased our EM position to a slight overweight to reflect these potentially positive developments.
Value and Growth
Recent market turmoil failed to flip the style derby from Growth to Value. Often, a market turn will produce a change in leadership, but the difficulty today is that Value tends to be loaded up with Financials, Energy, and Cyclicals, whereas Growth sectors are still in favor. While we are intrigued by the valuations offered in cheaper segments of the market, their continued poor price action keeps us slightly underweight Value. Currently, we prefer Growth and High Quality.
Large and Small Cap
Market leadership is with large cap Growth stocks. We are amazed that 40% of the smallest companies (by market cap) are losing money in what is widely seen as a strong domestic economy. If our view on accommodative economic and monetary stimulus comes to pass, we will look to add small cap exposure as a pro-cyclical position.
Defensive and Cyclical
Growth and Quality have been consistent outperformers of late and we are overweight both. Investor concerns over slowing earnings growth make the number of companies that are growing, scarcer, and therefore more valuable. A falling discount rate also benefits the Growth style over Value. We believe it will take a significant shift in market sentiment to knock Growth off its perch.
REITs: Negative and Positive
REITs have performed well and are considered one of the safe-haven yield plays. Valuations are high, however, and interest rates continue to be a key macro driver. We are not willing to chase REITs but would be interested if valuations pull back a bit.
Commodities: Negative and Positive
Inflation signs are weakening, and industrial commodity prices have fallen hard in recent months. Unless the global economy strengthens, we are reluctant to bottom fish in this area. Our expectation of a weaker U.S. dollar this year could help commodity indexes, but we think there are better ways to play that macro trend.