We view the current economic expansion and bull market in equities as having much in common with an aging runner. Both are now entering their 11th years and both could very well be sustained throughout 2019. However, they may advance at a slower pace than a few years ago and both will be more vulnerable to accident. This being the case, investors will need to be more disciplined both in the design and implementation of a strategy.
Ten years of monetary stimulus, economic growth and falling unemployment have succeeded in boosting home prices, bond prices and stock prices. Interestingly enough, though, they have not had a meaningful impact on consumer prices. In February, the overall consumer price index rose by 1.5%, while CPI excluding food and energy was up by 2.1% year-over-year… and a large portion of that was contributed by energy alone. Meanwhile, headline PCE, the Federal Reserve’s preferred inflation measure, and core PCE both remain below 2%.[i]
The bottom line is that asset-class performance is highly dependent on the state of the economic cycle and medium-term growth and inflation dynamics. Equities produce attractive returns in calendar quarters with stable to strong economic growth. In periods of low growth, which we categorize as quarters with real GDP of less than 1% quarter-over-quarter (QoQ) annualized, equities produce returns of only 0.3%. Clearly, investors should strive to allocate to equities during periods of stable to high growth and underweight equities in periods of low growth.
In the short run, a pause in rising rates and a growing economy still favors stocks over bonds. Within the bond market, while there may still be opportunities in higher yielding sectors, investors should consider dialing back on some of the riskier sectors. We see the recent run up in high-yield as a gift.
From a trading perspective, we would expect to see the broader markets pull back in the near-term, and we’d see that pullback as an opportunity to purchase equities.
Traditional financial advisors use asset allocations that are agnostic to the economic cycle and generally maintain a static allocation regardless of the growth and inflation stages of the economic cycle, making such strategies susceptible to large drawdowns observed during recessions and stagflationary periods.[ii] [iii] We encourage investors to utilize a pragmatic approach to asset allocation that, while maintaining correlation to one’s own personal financial plan, allows for overweighting equities during periods of low inflation and economic growth.
[i] U.S. Department of Labor, Bureau of Labor Statistics, USDL-19-0611; Pages 2-4; April 10, 2019
[ii] Brennan, Michael J.; Schwartz, Eduardo; Lagnado, Ronald; “Strategic Asset Allocation,” Journal of Economic Dynamics and Control, Volume 21, Issues 8-9, June 1997, Pages 1377-1403.
[iii] Hubert Dichtl, Wolfgang Drobetz, Martin Wambach. (2016) Testing Rebalancing Strategies for Stock-Bond Portfolios Across Different Asset Allocations,” Applied Economics. 48:9, pages 772-788.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
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