Investment Insights: Excerpts from our September report

Wade Balliet
Posted by Wade Balliet
Investment Strategy

The following are excerpts from the September 2016 “Investment Insights” report, produced by the Global Investment Management team. For the full report, click here.

Market strategy: Getting Fed up

Closeup on the eagle sculpture near top of the Federal Reserve building in Washington.To hike or not to hike, to raise or not to raise – the markets and the investment community just want it over with already! It’s true, the data has been a bit hit-or-miss as of late. However, the employment picture is still looking solid and inflation is holding steady, albeit a little low. As such, the interest rate discussion remains on the table and the possibility of one rate hike before year-end seems likely.

We believe that market volatility is likely to spike near each Fed rate meeting. But for what? The timing of a rate hike now or in December seems almost irrelevant in the context of a long-term gradual rise in rates. What is relevant is how investors should prepare for these shifts in policy.

Equities: Has the ex-ante been upped too high?

“Ex-ante” in Latin translates to “before the event” and is a term investment managers use to describe the forecast or expectation of a certain event, usually revolving around return or risk. The opposite, “ex-post,” translates to “what lies behind.” Both concepts play an important role in the current environment. Ex-ante, or expected, equity returns have been lowered in light of the ex-post results we have seen so far this year. This is exemplified in overstretched U.S. equity market valuations that seem to defy fundamentals and investor concerns. It would make anyone consider folding their cards and waiting for a better entry before upping the ante. As our titular question suggests, now may not be that time.

We are certainly not suggesting that a recession is looming anytime in the near future. In fact, consumer confidence is still quite high with improving household income and debt metrics, steadily growing wages, and continuing easy monetary policy despite a potential rate hike on the horizon. The expectation, however, for many markets, especially the U.S., is that each successive economic target and profit forecast must be hit in order to hold these gains and for the market to grind higher. The TINA argument, “There Is No Alternative,” can only go so far if the perfection that is priced into the markets isn’t met.

Fixed income: Pick up that can

The Federal Reserve is at the forefront on the list of investor concerns. After years of kicking the can down the road on rate hikes, the sheepish Fed finally followed through and marginally increased the fed funds rate in December last year. However, it seems the proverbial can is back in the picture. Each meeting of Fed governors has had financial markets abuzz and placing wagers on whether rates will rise or stay flat. The Fed, meanwhile, has been attempting to assure markets that rates will rise gradually.

Markets still appear to be coasting sideways as they await more definite news on rates and the overall economic outlook. Investment grade corporate bonds fluctuated between gains and losses before ending August up 20 basis points, while their high-yield counterparts returned 2.09%, according to Barclays index data. Mortgages and even municipal bonds were also relatively flat throughout the month, gaining just 12 basis points and 13 basis points, respectively, according to the same source.

Our strategies maintain a tilt toward bond sectors considered to be more stable in this environment, including government agencies and mortgages, and high quality corporate debt. Based on current bond market yields and the prospects for increasing rates, we believe prudent positioning is appropriate at this time.

Click here to read more of the “Investment Insights” report from September 2016.

Investing involves risk, including the possible loss of principal and fluctuation in value. Economic and market forecasts reflect subjective judgments and assumptions, and unexpected events may occur. Therefore, there can be no assurance that developments will transpire as forecasted. Nothing in this newsletter should be interpreted to state or imply that past results are an indication of future performance.

Fixed income securities are subject to interest rate, inflation, credit and default risk. The bond market is volatile. As interest rates rise, bond prices usually fall, and vice versa. The return of principal is not guaranteed, and prices may decline if an issuer fails to make timely payments or its credit strength weakens.

International securities involve additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

Diversification and asset allocation does not ensure a profit or guarantee against loss.

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