Financial advisors can turn to exchange traded fund allocation strategies to help enhance their fixed-income and equity exposure and to better attune their clients’ investment portfolios to the current market environment.
In the recent webcast, Macro Polo: Finding the Right Investment Strategy For the Moment, Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, outlined the current state of the market environment. With the S&P 500 entering a bear market, investors remained cautious about further Federal Reserve tightening while murmurs of a recession loom. Meanwhile, allocations to equities fell to their lowest level since late 2020, with cash allocations rising to their highest level in nearly a year. Consequently, the wild swings in markets are leaving the equity-bond differential range bound.
Looking ahead, Bartolini warned that bearish signals are mounting, with investors seeing continued volatility for the next six months. Sentiment readings are still below 100, indicating a slight defensive bias towards risk assets.
Bartolini also noted that growth forecasts continue to be revised downward in emerging markets while U.S. large-caps have witnessed growth revised higher. Nevertheless, earnings sentiment continues to weaken globally.
In the fixed-income markets, the entire yield curve moved higher in June but flattened as the short-end rose more than the long-end. The yield curve briefly inverted in June for the second time since 2019 on the heels of hotter-than-expected inflation and further growth curtailing Fed action, Bartolini added. While credit spreads slightly widened in June, levels are still below their long-term average. Additionally, core yields have increased, but most asset classes are just slightly above the levels of expected inflation and offer little real income.
Thomas Urano, managing partner, portfolio management at Sage Advisory, cautioned that financial conditions are tightening on par with prior recessions, with economic activity slowing globally. Commodities are also reflecting a global slowdown as prices may have already peaked.
Looking forward, options traders are betting that the Fed could be slowing down its monetary policy tightening. Urano noted that market expectations of the terminal Fed funds rates are falling. The futures pricing of the Secured Overnight Financing Rate (SOFR) tells us how the market is pricing in future FF rates. In addition to the expectation of the terminal rate falling, the market doesn’t expect to raise rates in 2023.
Urano even argued that the current tightening cycle is more aggressively priced in than usual. The aggressive Fed tightening expectation has been priced into rates early, or earlier than in past cycles. This has resulted in returns far from the usual pattern during rate cycles. Higher yields across the curve will dampen the negative impact of spread widening from current levels. Given the flatness of the curve, there would be a muted impact on the front end of the curve.
Consequently, Urano believed that growth concerns and balance sheet tightening could continue to pressure spreads near-term. However, valuations are better compensating for these risks and suggest upside opportunities over the next 12 to 18-month period.
Bryan Novak, senior managing director at Astor Investment Management, contended that while rates are discounting multiples, next year’s growth estimates have come down fast as well. Consequently, a catalyst for markets to advance will require terminal rate certainty, peak inflation, and improvement in the forward-looking growth outlook.
On the inflation front, Novak argued that demand and supply-based contributions to inflation have both been strong, and recent data suggested the worst may be behind us.
Investors may begin to re-evaluate their fixed-income portfolios with the addition of ETF strategies to better manage market exposures. Novak highlighted fixed income ETFs, which could allow for flexible and tactical portfolio solutions, managing credit and interest rate risk.
Financial advisors who are interested in learning more about investment strategies for the current market can watch the webcast here on demand.