Asset Allocation Update: Growth Moderates, But Fundamentals Remain Supportive

03.18.2019 - Viraj B. Patel, CFA, FRM, CAIA


Recently, market sentiment and prices have swung to extremes during this late stage of the economic growth cycle. 

While leading economic indicators clearly softened last year, we believe both economic and corporate fundamentals remain strong enough to support our constructive outlook and slight overweight recommendation for equities. We also remain underweight fixed income and have increased our cash holdings to take advantage of market dislocations.

Equities: Patches of Opportunity

In the US, we remain overweight mid- and small-cap equities, which are benefitting from tax reform, deregulation and other stimulative policy measures. They are typically less sensitive to trade tensions than largecaps and considered attractive targets for larger companies as M&A activity ramps up.

Within international developed markets, Japan is showing signs that longterm structural reforms are benefiting certain sectors and stocks. We remain cautious about the prospects of continued Yen weakness, despite indications that the Bank of Japan might consider easing. Moderating global growth hit the eurozone especially hard, but with rates already at historically low levels, EU policymakers may have limited tools available to stimulate growth.

Our neutral view of emerging markets also remains in place. EM equities were dragged down by a stronger dollar and rising US interest rates last year, and the Fed’s pause appears to be priced into current valuations. Our outlook for China has improved slightly as stimulus measures percolate through the real economy and credit conditions begin to improve.

Fixed Income: The Fed Pauses

Indications that the Fed is taking a cautious approach to rate hikes helped stabilize Treasury yields and prices in early 2019. We are watching the Fed carefully for hints of its next rate move, as well as any indications of possible changes to their balance sheet policy.

Within the US, we prefer investment-grade credit over government bonds. Despite the Fed’s pause, we are also maintaining a shorter average duration than our benchmark to guard against interest rate risk. Rates remain low by historical standards, which means opportunities for total return are limited.

In the municipal bond market, we continue to see tax-favored income potential for high earners. As the market adjusts to reduced supply and weaker demand, we are taking a highly selective approach, generally favoring higher credit quality, liquidity and revenue bonds over general obligation bonds.

Alternatives: Managing Risk

When market volatility escalates, liquid alternatives can provide valuable downside protection. Therefore, we typically recommend a portfolio allocation of 5% to 10% for our clients. In addition, we are actively helping investors find attractive entry points in the private equity market, focusing on deals that add value rather than relying on a rising market or financial engineering for returns.

This communication is intended solely to provide general information. The information and opinions stated are as of March 18, 2019 and may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

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