The last week or so has certainly caused some anxiety among
equity and fixed income investors. I
decided Sunday and Monday to look more in depth and draw some conclusions.
What follows is my analysis, which I sent out to our firm;
however, does NOT include the corresponding research behind it or the awesome,
pretty charts. I should note that
without the research in which to refer, the bullet points may be a bit hard to
digest. In those instances, if anyone wishes
further details please email me (zabrams@capitaladvisorsltd.com).
As I write this, prices have seen some reversal, which in
some ways encapsulates what I am trying to illustrate below. The key, whether or not I am right or whether
I am wrong, is to focus on the intermediate-term window, try and funnel out
what is happening in these violent short-term moves, and don’t panic!!
- The markets of late have been interesting as stocks and bonds have both seen downward market volatility. This makes asset allocation a nasty task
- Starting in 2009, rising yields have been bullish for stocks. Falling yields have been bearish until they hit their floor. However, the general low level of interest rates has been bullish for stocks (lower interest rates = lower discount rate = higher valuations AND lower interest rates = lower cost of borrowing = higher EPS). Thus, it seems logical that the higher yields, higher stock prices makes sense for the time being as the move in interest rates has been large and could be construed as a secular change
- When put in perspective neither stocks or equities looks as bad, but should continue to be watched. Further, a 3% to 4% loss in bond portfolios is hardly reason for panic
- Bonds in particular appear due for at the very least a short-term bounce
- Stocks could have more to go, but should have a floor as:
- Lower prices increase likelihood of Fed loosing
- Economic data is too good for stocks to ignore
- It’s likely that either bond yields settle OR move down given at some point the rising yields will probably hurt the economy and loosen Fed policy
- Even If they don’t (e.g. the economy gains in strength) then properly allocated fixed income portfolios should be hedged as:
- Stocks should perform well
- Active fixed income management should outperform passive
- Duration should be relatively low
- As it relates to portfolio management the above points to:
- Letting this FMOC re-calibration shakeout and remaining calm
- If there is a need to pull the trigger, a small move to cash is probably the best place to go instead of a secular change in the portfolio (e.g. selling a portion of intermediate-term bonds and moving to cash > selling all intermediate-term bonds and moving to short-term bonds)
- Even if this is the start of a secular move in interest rates, the odds are likely there will be a short-term reversal
- Use the market trends as a guide and not a road map to violent short-term moves
- At some point soon, diversification will work again in terms of moderating (though not completely containing) risk
- I still think the highest probability path is this: rapid rise in interest rates hurts economy > equities struggle > yields lower in anticipation of Fed loosening (maybe not QE though) + safety > stocks fall until easing back on > yields range bound.
- Note: an alternative would be if interest rates continue to rise as growth improves, which again is bullish for equities. Not so much for bonds
Past performance is no guarantee of future
results. Diversification does not guarantee a profit or protect
against a loss. International investing involves special risks, including, but
not limited to, the possibility of substantial volatility due to
currency fluctuation and political uncertainties. The views and
opinions expressed herein are those of the author(s) noted and may or may not
represent the views of Capital Analysts, Inc. or Lincoln Investment. Nothing in the above writing should be taken
as an investment recommendation.
