A Moment to Exit – Or Seek Opportunities?
As we have been discussing since early August, volatility was bound to rise given slowing economic growth and the likelihood of an impending Fed hike. Indeed, the recent correction has returned some value to markets. Still, we expect volatility to remain elevated until either global growth stabilizes and/or investors get some clarity from the Fed.
But we do not believe investors should be abandoning risky assets. Our basic portfolio positioning is unchanged: We would still favor a portfolio tilted toward equities, select credit, tax-exempt bonds and inflation protection through Treasury Inflation Protected Securities (TIPS) rather than physical commodities. And we would look to take advantage of some pockets of value, as well as assets that are best positioned in the current "Fed hike, but low-growth environment."
Starting with stocks, we would suggest adding to positions in international developed markets, particularly Europe, which remains attractively priced and is seeing an improving economy. New economic data revealed that euro-area unemployment fell to the lowest level in three years. In addition, given stubbornly low inflation and concerns over global growth, there is also the prospect for an extension of the current quantitative easing program. In the U.S., we see large-cap, cyclical companies as best positioned to withstand the start of the Fed's tightening cycle.
We also maintain a preference for credit within fixed income. Despite the equity market volatility, high yield has stabilized over the past week and yields remain attractive. Investment-grade credit is also looking cheap, although investors may want to hold off until later this fall given pending supply. Finally, as we have been noting, tax-exempt bonds are offering compelling yields relative to taxable instruments of the same maturity. Despite the recent rise in volatility, municipals have held up relatively well.
Areas where we would remain cautious include U.S. Treasuries and commodities. On the former, with inflation expectations still near recent lows, we’d prefer to get our duration from TIPS rather than traditional Treasuries. On commodities, we would remain cautious. This asset class has struggled all year and will continue to be pressured by sluggish growth, oversupply and the potential for a Fed-induced strengthening of the dollar.
Overall, however, this is an environment in which it is best to prepare for more bumps in the road, but stay the course and make sure you are taking advantage of opportunities along the way as we enter the fall season.
Russ Koesterich, CFA
Global Chief Investment Strategist and Head of the Model Portfolio & Solutions Business