The Impact of the Fed
Shifting incentives have also played a very important role in investment decisions lately. Investors have reached for incremental yield as a direct result of the Fed’s decision to hold short-term interest rates near zero for the past five years and its efforts to suppress intermediate- and long-term interest rates through quantitative easing. As long as the economy continues to gain traction, investors have been willing to boost allocations to credit risk and dividend paying equities in order to obtain more yield. As a result, corporate bonds now make up 50% of all household bond market ownership – an all-time high.
At the Fed meeting last December when tapering was officially first announced, Fed officials were “concerned about the marginal cost” of additional asset purchases, fearing that more quantitative easing could lead to “excessive risk-taking in the financial sector,” according to Fed meeting minutes. My team’s analysis shows that Fed officials are right to worry about the “costs” of their highly accommodative monetary policy stance.
What Investors Should Consider
But does this mean that investors should adopt a more conservative stance? I still think that an improving global economy and growing corporate incomes will support risky assets over the balance of 2014.
However, investors would do well to consider some strategies to build some ballast into their portfolios, such as rebalancing with a tilt toward value. Rather than simply letting last year’s winners ride, investors should consider periodically rebalancing their portfolios. In particular, in today’s environment, chasing last year’s winners has been a poor strategy year-to-date. Instead, investors should consider embracing some of last year’s losers and adopting a general bias toward value-oriented areas of the market.
As for where the value is, I still believe stocks offer better value than bonds, even after a five-year bull market. Within stocks, the shift toward value from growth supports my preference for large cap and mega cap names over small cap stocks, as well as my preference for international equities and less expensive sectors of the equity market, such as energy and technology.
Sources: Linked to throughout post, Bloomberg, BlackRock research
Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog and you can find more of his posts here.