As we look at the fallout from the shifting economic environment, investors will have to readjust their strategies and investment portfolios.
In the recent webcast, What Rising Rates and a Shifting Economic Landscape Mean for Your Portfolio, Matthew Bartolini, head of SPDR® Americas Research, State Street Global Advisors, notes that continued headwinds like inflation, Fed hawkishness, and Russia’s war with Ukraine have all weighed on asset classes this past month. The falling supply and rebounding post-COVID demand have also contributed to broad commodities’ continued outperformance.
On the fixed-income side, Bartolini pointed out that with yields rising, bonds continued posting losses led by long-duration and investment-grade credits, while senior loans held up better. The benchmark U.S. Aggregate Bond Index also suffered through its worst drawdown ever in Q1.
Near-term inflation expectations have moved dramatically higher since December, driving expectations of more aggressive monetary tightening for this year. The futures markets are even pricing in a 90% probability of at least a 2.25% target rate by the end of this year.
“With real yields low, investors should look to target credit markets that have a yield above inflation expectations while trimming duration,” Bartolini says.
Meanwhile, Bartolini outlined the implied volatility, which edged down from March and the onset of the war, with rates volatility at its highest level since the onset of the pandemic.
In this type of market environment, retail investors, hedge funds, and risk-controlled exposures have reduced their equity exposures amid elevated equity and bond volatility. Investor sentiment remains negative, with bullish AAII indicators entering their tenth-percentile on a three-year look back during April.
Looking at the markets, historical valuations for U.S. Value and Growth funds have hovered around their top decile in April. Earnings sentiment has waned in most regions, evidenced by more downward revisions and lower growth estimates. Additionally, strong earnings revisions and growth estimates in energy have lifted earnings prospects of the broad market, while analysts have become less optimistic about growth in most other sectors, Bartolini adds.
To help financial advisors better adapt to these market conditions, Eric Biegeleisen, partner, deputy chief investment officer, 3EDGE Asset Management, outlined the 3EDGE model portfolio solutions. Their multi-asset core solutions include a conservative strategy blended portfolio holding predominantly fixed income and also includes equities and real assets. The total return strategy includes a blended portfolio holding a mix of equities, real assets, and fixed income. The growth strategy includes a blended portfolio with the potential for high equity holdings. It also includes real assets and fixed income. Additionally, the multi-asset income solution income plus strategy includes a blended portfolio of traditional equity income and fixed income sources as well as non-traditional sources of income.
These types of portfolios solutions can help financial advisors readjust their investment portfolios to a regime shift as the rules of investing have changed in an environment dominated by inflationary forces like negative real interest rates, strengthening labor unions, rising wages, increased local production, tilt toward short-duration assets, and the rise of real assets.
Greg Ellston, chief investment officer — Asset Allocation, Confluence Investment Management, notes that the Federal Reserve has adopted a much more hawkish monetary policy stance in its attempt to combat inflation. Global central banks, in contrast, have varying policy responses ranging from extensively accommodative to increasingly hawkish. Consequently, given the shifting landscape, the potential for a policy mistake leading to an economic slowdown or even a recession has increased.
Due to this shifting economic and market outlook, Ellston argues for portfolio adjustments, such as fixed income exposure to the mid-section of the yield curve and equity exposure reduced to underweight across all portfolios. Additionally, commodities could be on the cusp of a multi-year bull market.
“In the equity exposure, we maintain a bias to value,” Ellston says. “We have also become more defensive in our sector allocations.”
Confluence Investment Management LLC also offers a suite of ETF model portfolio strategies, such as the income strategy, which primarily focuses on reliable income and is appropriate as a complementary strategy for investors in the distribution phase of their investments. Confluence’s income with growth strategy is oriented toward reliable income, moderate volatility, long-term growth, and principal preservation. Additionally, Confluence’s growth and income strategy combines growth and income objectives with more emphasis on growth.
Financial advisors who are interested in learning more about portfolio strategies for rising rates can watch the webcast here on demand