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Clients and Friends,
As we approach year-end, we’ve made the following strategic adjustments to the core portfolios to align with the current market environment and potential opportunities:
- Increased Equity Exposure: We have added 3% to stocks across all but our most aggressive and most conservative portfolios, targeting an overweight position versus our portfolio benchmarks. This adjustment reflects our confidence in the historically favorable November-December seasonal period, and is intended to capitalize on a potential post-election rally through year-end.
- Focus on U.S. Stocks with Quality Characteristics: We’ve leaned further into U.S. stocks with strong recent momentum, as we see opportunities for growth in the domestic market compared to international equities, while eliminating our small cap value investment.
- Maintained Credit Risk and Duration Positioning: We’ve maintained our aversion to longer-dated credit and credit risk, continuing to hold more short-term and floating rate bonds and loans.
Rationale for Changes:
With the U.S. presidential election decided, and without a long-anticipated delay in announcing the victor, we believe that markets will now be able to move forward with a range of potential legislative and regulatory outcomes in the U.S., providing an increased level of clarity both for businesses and investors. For businesses, pent-up activity from capital allocation decisions that had previously been delayed should provide a tailwind for the economy, and therefore for the markets. This activity, when reflected in macroeconomic figures, should continue to drive positive investor sentiment, while these shifts, combined with an economy showing resilience and moderated inflation pressures as may be seen in the graphs below, support our decision to increase risk exposure and position portfolios for a broader relief rally.
We continue to prefer U.S. stocks, as well as for large cap stocks, in our core portfolios. In the U.S., consumer spending remains robust, and most economic reports have indicated strength and resilience without portraying an economy that is too hot, possibly portending a return to increased levels of inflation. By contrast, many European economies continue to sputter, including manufacturing stalwart Germany, which has recently narrowly avoided a recession due to high energy prices and weakness in China, one of their main trading partners.
However, that resiliency in the U.S. economy has yet to trickle down to listed small cap companies, which have struggled to drive growth and expand margins like high quality, large cap companies have done:
Against this backdrop, the small cap index, as represented by the Russell 2000, has risen over 20% this year (Source: YCharts), without any fundamental driver of this return. In this context, we have eliminated our small cap value exposure, reallocating that exposure to the larger capitalization, higher quality investments that are exhibiting the traits exhibited above. We have kept our small cap growth manager, who we trust to pick through that universe and find companies that are growing faster with better margins than the index as a whole.
On the bond side, we remain averse to substantially lengthening our duration, or the term of the bonds in the portfolios, as history continues to repeat itself with almost wishful thinking on interest rate cuts. Roughly a year ago, market prognosticators were assuming that the Federal Reserve would cut rates seven times during 2024, leading to many calls to lengthen the duration of bond portfolios, as in theory the longer end of the yield curve benefits most substantially from these cuts. Not only did we not believe that there would be that many cuts, but we also believed that other factors, including the deficit and debt issues that have suddenly come to the fore, would begin to exert their presence, with possible negative effects on longer-term bond prices.
As we sit here today, almost in December, the Fed has cut rates twice, with one more cut in December seemingly a 50/50 proposition. While inflation has continued to trend downward, it has taken longer, and become a bit stickier than many believed it would be. In addition to that, the debt and deficits issue has caused a decent amount of volatility towards the longer end of the curve, leading to greater fluctuations in bond prices. That is not the point of having bonds in our portfolios, and so we are willing to methodically recalibrate the bond portion of our portfolio over time, rather than reallocate it all at once. The end result will be that we hold shorter term bonds for a bit longer as we wait to see how the Fed moves forward, and we will be very cautious about extending the term of the bonds we hold, as we would like to avoid the longer, presently more volatile end of the yield curve.
As always, if you have any questions, or would like to speak to a member of our team regarding your portfolio, please do not hesitate to give us a call.
In the meantime, we hope you and your loved ones have a wonderful Thanksgiving. We are thankful and grateful for you.
Kindred Wealth Partners