Wealth Insights | Weekly Market Analysis | Economy | Asset Allocation
Weekly Market Analysis - Be Ready for the Unexpected
Posted on3 Things to Know
Don’t React but Ensure Portfolios are Prepared
The clash between Israel and Iran highlights the less secure environment for global energy supplies. As we noted in last weekend’s CIO Strategy Bulletin, for most investors, reacting to such news is too late to be effective. Portfolios should be prepared for a less-than-ideal world as embodied in our Wealth Outlook 2024 theme “Economic Security.”
Injecting Security while Balancing Income and Growth
Economic Security requires redundant energy supplies, defense deterrents, cyber-security defense and tech supply chain investment. These are all potentially robust long-term growth investments in equities markets, despite their usual volatility. We also suggest a “barbell” approach balancing income with growth opportunities. Intermediate US investment grade yields approaching 6% provide the former.
The “Fed Question” is Back
One pressing question for investors beyond unpredictable shocks is resurfacing from 2022-2023. Will the Federal Reserve be able to tame inflation without collapsing the economy? Markets now show “healthy concern.” This may actually improve future returns. Among a variety of factors, without pricing in strong easing steps by the Fed, markets are much less vulnerable to disappointment.
Summary
In the hours after Iran launched missiles and drones at Israel on April 13, pundits were quickly jumping to conclusions. Some saw the moment as the tipping point for a far more destructive and wide regional conflict. Others were quick to dismiss it as a meaningless display of force. Collectively, traders acted on their hunches, guessing. This was all repeated in the immediate aftermath of Israel’s retaliation on Friday.
As we noted in last weekend’s CIO Strategy Bulletin, for most investors, reacting to such news is too late to be effective. This was what we had in mind as our Global Investment Committee (GIC) met this week and maintained a cautiously positive 2% overweight allocation in equities with a large helping of high-grade US bonds at a medium average duration. Our favored bond segments now yield close to 6% yield for a 4–5-year maturity (see chart). We take this position to earn yields that will endure beyond the Fed’s long-in-the-tooth tightening cycle.
Portfolio considerations
Global supply shocks are very rare. The mere prospect for one still suggests we should invest with a range of possible positive and negative economic outcomes in mind, rather than build portfolios only seeking the highest absolute returns regardless of risk. At our Global Investment Committee (GIC), we held to a conservative 2% overweight in equities with a large position in safer intermediate US high grade bonds. We have also swerved tactically towards Healthcare within equities. In part, this is because of their “defensive” and “quality” characteristics. We continue to recommend risk hedges for suitable investors as equity hedging costs remain historically inexpensive.
Source: Bloomberg, April 18, 2024. The proxy for IG corporates is the Bloomberg US Intermediate Grade Corporate Bond Index. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events.
Don’t React but Ensure Portfolios are Prepared
In the hours after Iran launched missiles and drones at Israel on April 13, pundits were quickly jumping to conclusions. Some saw the moment as the tipping point for a far more destructive and wide regional conflict. Others were quick to dismiss it as a meaningless display of force. Collectively, traders acted on their hunches, guessing. This was all repeated in the immediate aftermath of Israel’s retaliation on Friday.
As we noted in last weekend’s CIO Strategy Bulletin, for most investors, reacting to such news is too late to be effective. Experience tells us it would more likely harm portfolios than help. Portfolios should be prepared for a less-than-ideal world as embodied in our Wealth Outlook 2024 theme “Economic Security.”
Security threats to supply, such as the conflict in the Middle East, are also a key risk to short-run price stability. We consider supply fundamentals critical to maintaining what has been a global pattern of decelerating inflation following the pandemic surge. Commodity prices are getting much attention of late, but let’s recall that global crude oil quotes were $89 before the massive shift in global supply following the Russian invasion of Ukraine and are near that level even now after the shocking new events in the Middle East.
Injecting Security while Balancing Income and Growth
Economic security requires redundant energy supplies, defense deterrents, cyber-security defense and increased tech supply chain investments. These are all robust long-term growth investments in equities markets, despite their usual volatility. Global supply shocks are very rare, but they still suggest we should invest with a range of possible positive and negative economic outcomes in mind rather than build portfolios that only seek the highest absolute return, regardless of risk.
As we’ve described in recent months, we would expect to hold a larger allocation to global equities than our present net 2% over the course of an economic expansion. This is particularly true if global interest rates are “tamed.” But present risks, firm equity markets and rising rates leave us holding to a more conservative asset allocation for now.
The “Fed Question” is Back
Will the Federal Reserve be able to tame inflation without collapsing the economy?
We continue to see a favorable rebalancing of global demand and supply amid exogenous risks. However, the path to realizing a happy mix of solid growth and weak inflation was priced-in unusually smoothly in markets during the past half year. For example, up until the past two weeks, US equities had not posted a single decline of 2% or more since October 2023.
Let’s remember what followed the Fed’s tightening of 2022/2023 – disinflation, stronger growth and stronger returns for both equities and bonds. Many issues, from geopolitical risks to a possible “Fed error,” might make the “echo” of 2022 less profoundly positive once it is past. But “healthy doubt” and normal volatility should not derail investors from exposure to economic development and technological progress – the drivers of equity returns.
US equities have been the strongest-returning major asset class for the past century and have posted positive returns in 74% of all years since WWII. Yet this includes an average inter-year decline of 12%. Nearly 40% of monthly returns for the S&P 500 have been negative. In short, higher return, higher risk assets usually don’t enjoy such a smooth ride without interruption. Over the past decade, the Fed’s forecast for its policy rate has been off the mark looking ahead 12 months by an average of 0.94 percentage points. Their forecasts have been off as much as 3.7 percentage points for the year ahead. We noted this after markets have swung from an assumption of two rate cuts to seven and back already this year. We would suggest great caution in assuming markets now suddenly have the right forecast for US monetary policy.
