Investment Insights: An extraordinary unwinding

Wade Balliet
Posted by Wade Balliet
Investment Strategy

This weekly report presents insights from our Global Investment Management team.

Rock of Gilbraltar shrounded by a large cloud at sunset looming over a nearby beach.U.S. stocks are struggling in the kickoff to the second quarter as most markets fell in the few first days of trading. Despite consumer confidence reaching its highest level in almost two decades, according to Conference Board data, unease concerning domestic growth may be on the rise. Markets are being heavily influenced by proposed policy changes and how those will sway economic growth.

One of those most recent policies revolves around a potential change to work visas within the U.S., which could impact tech companies hardest due to labor force demographics. Investors are also looking to the next bout of earnings numbers to find a bearing. Only a handful of companies within the S&P 500 have reported so far, but the figures are looking healthy.

The Wall Street Journal recently reported that Federal Reserve officials may be pausing rate hikes after this year, opting to address a ballooned $4.5 trillion balance sheet of Treasuries and mortgage-backed securities. While this is only a potential – a word that has become commonplace for policy changes – plan for the Fed, it has strong implications. Fed Chair Yellen has now shown the markets that the Fed is having serious discussions about unwinding the trillions in quantitative easing assets that are still being held. Investors will likely need a well-telegraphed timeline for the “quantitative tightening” in order to gradually digest the news. Shrinking that portfolio could push up longer-term rates as the balance sheet normalizes; the Fed’s pre-2008 debt holdings were around $900 billion, but may end the program higher than historical levels.

The consequences of Britain leaving the EU seem to already be showing. Since triggering the formal procedure, British government bonds, also known as “gilts,” appreciated through yesterday as yields dropped across the curve. However, the U.K. stock market, as measured by the FTSE 100 Index, lost 64 basis points over the same period. The outlook for the U.K. economy will largely depend on the exit negotiation process, but there may be some unorthodox requests and even a redrawing of national borders. Gibraltar, a British territory located in the southern part of Spain and adjacent to the similarly named strait that separates Europe from Africa, has been a historically disputed topic for the Spanish and U.K. governments. Interestingly, the European council appears to be supporting Spain by including the territory as part of the talks. While this may be a “high ball” start to the mediations, it certainly sets a tone for what may come.

We recently made a shift in our strategies to capture gains in stocks and increase exposure to alternative assets. Reducing select U.S. stocks and increasing alternative fixed income is expected to preserve principal and improve the risk and return profile of the strategies. We believe the modification to our international stock allocations by shifting toward lower capitalization stocks will likely help as currency fluctuates and economic growth improves abroad. Our team is comfortable taking on more credit risk in bonds, as value opportunities reveal themselves, rather than within interest rates. The GIM team believes the next Fed hike will be at their June meeting with a subsequent hike in December. The possible unwinding of the Fed’s holdings may push up the third and final hike for 2017 to September in order to make way for the asset sales next year. Rate hikes and the “quantitative tightening” will more than likely not occur at the same time, which could mean a pause for rate increases in 2018.

Table showing various market returns as of 4/4/17

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. The information in this newsletter is for informational purposes only and is not intended to be investment advice or a recommendation. 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 do not ensure a profit or guarantee against loss.

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