All Posts Tagged: storm warning

Investment Insights: Winter is coming

Wade Balliet
Posted by Wade Balliet
Investment Strategy

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

View of lighthouse in the distance as large surf crashes break against its base while the dark sky threatens a storm.The rally experienced by equity markets in the afterglow of both the U.S. election and now the Italian reform vote has exposed a surprising tolerance for uncertainty. To their credit, after the Brexit and now Trump’s victory, investors seem to be proficient in trading based on the increase in populism. It appears as though just when asset managers think that volatility will spike, markets digest the news and carry on. When considering the market’s most recent unresponsiveness to the Italian referendum as well as the current levels and valuations of major equity markets, we believe an investor winter storm warning may soon be in effect and international stock markets could see the brunt of a frigid start to 2017.

The bull market in U.S. stocks, as represented by the S&P 500, is now in its second longest stretch ever. When you add an aging 8-year business cycle into the mix, it causes some worries and challenges for asset allocators. As a byproduct, the disconnect between business and market cycles has resulted in elevated valuations with the S&P 500 Index price-earnings ratio reaching toward 21, far above its long-term average of 16.5, according to Bloomberg data. These points combined with a possible reversal of a theme that we had mentioned in earlier insights, the “TINA” (there is no alternative) argument, could result in a rotation of allocations.

As overall yields have increased and municipal bond spreads widen, some equity or yield investors may take the opportunity to shift back toward higher quality allocations, such as U.S. government and investment grade corporate bonds. With the 10-year spread widening 0.56% in the month of November, bond investors saw one of the largest monthly price declines in recent history. For some investors holding both stocks and bonds, this may have been enough to erase gains achieved by U.S. equity markets over the past months. Meanwhile, international markets have been struggling when compared to domestic stocks. Relatively weak fundamentals across the European Union combined with financial sector worries in certain countries have resulted in more uncertainty and lackluster returns, despite more attractive valuations.

With this said if the market can keep its current momentum into an earnings season that produces reports which hit close to expectation, and consumer optimism as well as business sentiment remains positive, we could see a market that would carry us into a “domestic policy honeymoon” where the economic cycle gains some fervor. Fundamentals within the U.S. are still pretty solid – justifying our slight overweight to the U.S. market – although the GIM team has been taking strategic profits within that allocation. U.S. bond yields, as previously mentioned, have risen to a point where we were comfortable adding a bit of duration and increasing our allocation to U.S. government securities. Even with this increase, we remain underweight to the U.S. government sector, instead favoring spread product which can be used to damper movements in interest rates while also collecting on higher yields in a recovering environment.

Our strategies continue to hold allocations with a slight overweight to stocks, which has been additive given the run-up in equities. We have been proactive in risk reduction within all three major asset classes: equities, fixed income, and alternative investments. We believe a storm may be on the horizon. Just as meteorologists attempt to forecast weather patterns, despite high uncertainty, we asset managers are seeing clouds on the horizon – now we must determine when the first drops will fall.

Chart showing recent market returns, as of 12/6

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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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