Investment Insights: Shaking it off and shaking our heads
This weekly report presents insights from our Global Investment Management team.
The July 4th holiday had its usual fervor of parades, barbecues, and libations while gazing into the sky for the next burst from a firework. This year it may have also marked a more serious milestone in aerial blasts. U.S. officials confirmed that North Korea has developed and tested an intercontinental ballistic missile, or ICBM. The labeling of the most recent North Korean ICBM effectively signifies that the United States believes a North Korean rocket may have the capacity to reach the shores of the U.S. and other nations around the world.
The provocation comes as the G20 summit commences later this week and should guarantee that, in addition to the other issues facing the globe, this will be a major topic of discussion amongst the world’s most prominent leaders. The vital question will not only be how to deal with the current actions from North Korea, but more importantly what steps leaders will take toward denuclearization. Additional sanctions could be enacted, but most heads and eyes are turning toward China for a more definitive solution as North Korea’s one and only ally.
Markets have chimed in on the current action, though it came in the form of a whisper rather than a roar. As expected, the day after the test markets opened lower; however, the depth of the drop reflected the resiliency of the markets. In early trading Wednesday, the S&P 500 Index dropped less than 10 points, or around a third of a percent. This has been a general theme of the equity markets and fits with the motto, “Keep calm and carry on.” Where does this seemingly endless ability to shake off most, if not all, volatility-driven news come from?
Most investors would point to the possibility of detraction rather than the fundamental drivers of the current market status. The U.S. growth path is still minimally deterred and may actually perform above trend for the rest of the year. The Federal Reserve is continuing to embark upon tightening its policy, although it remains quite accommodative by historical measures. Additionally, regardless of what the Fed is doing or planning on doing, it will take time for the actions of today to affect the economy of tomorrow. In fact, we have heard some investors start the mantra to raise rates just so that the Fed has room to decrease them in the case of a slowdown.
We believe this is counterintuitive and instead would rather see a continued plod of U.S. growth with measured Fed behavior. The Fed is more than likely the most important factor in this part of the cycle. Just as the hawk swoops in for the older, more mature field mice, it may be the hawks of the Fed that kill the third longest expansion in U.S. history. Once again the markets seem to take this in stride with the only dissention being within the bond markets. The 10-year Treasury is hovering around pre-election yields, which may indicate that bond investors are hesitant to believe that the growth path is untenable or that inflation won’t be able to rise much above the Fed’s target.
For now there are quite a few stories to tell around the picnic table: the U.S. economy is set to do more of the same, bond markets are shaking their head, and a stock market shaking off volatility-inducing headlines. To add to the mix, there is a global growth narrative that has to contend with Brexit, a North Korean ICBM, continued tension between developed and developing nations, and a more constant threat of global terrorism.
During this American holiday week, we continue our asset allocation approach in patriotic style with an overweight to U.S. equities and a tip of our hat to other developed nations’ stocks with an overweight to both asset classes. We continue to underweight emerging market stocks as we believe that higher interest rates in the U.S. and a stronger dollar may unwind the current rally. Finally, we remain skeptical of the current bond market theory and are keeping a minor underweight on duration, but with an underweight to lower quality bonds in the portfolio as we continue to monitor economic data.
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.