A strong U.S. economy, continued global growth improvement, a concerted effort by global central banks to remain accommodative as long as possible, and a general sense of complacency about valuations in the equity markets provided the backdrop for 2017’s wins. Globally diversified portfolios performed well, as international and emerging markets equities contributed meaningfully to returns, and concerns about a sharp swoon in bonds proved unfounded. Many of the same forces are at work in 2018, although the risks have certainly increased as we move deeper into the current expansion. Investors appear less complacent, which has led to greater volatility in asset prices; however, this may lead to a renewed focus on fundamentals and valuation, which could drive upside in portions of the market which have not participated as fully in the run.
We will continue to focus on industries and companies with pricing power that benefit from tax reform, a reflationary environment, and higher interest rates.
With that said, we remain overweight equities versus bonds. While this has been our stance over the last several years, we acknowledge that the length of the current period of outperformance of equities over bonds creates potential concern for investors. However, our view is that a sustained pullback in equity prices would be precipitated in this current environment by a U.S. recession, and as we sit, we are challenged to find evidence pointing to such an outcome in 2018, and possibly into 2019. Within U.S. equities, given our expectations for continued economic growth, we will continue to focus on industries and companies with pricing power that benefit from tax reform, a reflationary environment, and higher interest rates. Our team remains overweight in information technology and health care, given the opportunity presented by both the hardware replacement cycle in technology and the positive demographic trends and valuations in health care. Our team is also positive on the financials sector, given the benefit from expanding margins and multi-decade low credit costs. Less attractive are consumer discretionary stocks, which have benefited from the strong labor market, rising wages, tax reform and a strong wealth effect, but have valuations which are reflective of recent strength.
The relative attractiveness of international equities has been a consistent theme for us the past two years. While we acknowledge that the accommodative monetary policy stance(s) adopted by the European Central Bank, Bank of Japan, and Bank of England are likely to become less accommodative over the course of the next one to two years, the combination of a longer runway to tightening and still relatively attractive valuations create our constructive view. U.K. stocks, in particular, have lagged meaningfully over the past several months as Brexit negotiations created uncertainty. With a framework now in place, investors may feel more comfortable stepping thoughtfully back into these stocks. Emerging markets equities enjoyed another strong quarter, on the back of a terrific 2018. With the relative underperformance of these stocks over the last few years, there remains opportunity, and a U.S. dollar that appears unable to sustain any meaningful momentum higher should act as a tailwind for these names as well.
Triple B and split-rated bonds in appropriate sectors will still be an effective way to add excess performance.
As noted above, we remain underweight bonds versus equities. Within our taxable bond portfolios, the team continues to favor corporate bonds although efforts to decrease credit exposure and increase Treasury and Agency exposure will be ongoing in 2018. Volatility within corporate bonds has increased in the first quarter of 2018, although the cause has been tariff and trade war fears as opposed to increased M&A activity. While tariffs may lead to higher prices and inflation in the near term, inflation without growth would ultimately be a negative for the economy and result in lower yields. From a duration standpoint, our corporate bond portfolios are neutral to slightly longer than the relevant benchmarks, with the thought that rates reached their near-term peak in late February. Triple B and split-rated bonds in appropriate sectors will still be an effective way to add excess performance if current market fears recede. A paired allocation to Treasuries, Agencies, and Mortgage Back Securities will be an important hedge if a risk-off mentality persists. In our municipal bond portfolios, our overall outlook on credit quality remains strong – the well-publicized pockets of weakness notwithstanding. From a duration standpoint, portfolios are typically close to neutral when compared with the benchmark, and the team is focusing on higher quality credits, instead earning additional yield by adding callable bonds to portfolios. An increase in yields or cheapening in the municipal bond sector will generally be treated as an opportunity to add duration to portfolios and lock-in attractive tax-exempt yields for future years.
Finally, real asset performance has proven to be somewhat mixed for investors thus far in 2018. As is often the case in a rising interest rate environment, REITs have underperformed versus the broader equity universe, but remain a source of yield for investors. Commodities may become more attractive as inflation picks up, but any indication of slowing global growth is likely to hit both industrial metal and energy prices and create a ceiling on gains in the space. We remain neutral in our stance.
The opinions expressed and information contained in this publication are given in good faith, may be subject to change without notice, and are as of the date issued. This publication discusses general market activity, industry or sector trends, or other broad-based economic, market or political conditions and should not be construed as research or investment advice and does not represent a complete analysis of every material fact with respect to the economy, financial markets, interest rates, and any industry or sector mentioned in the publication. The graphs and charts presented were created for informational purpose only and use data sourced from Bloomberg and Morningstar. The accuracy and completeness of sourced data is believed to be reliable, but has not been independently verified.
There is no guarantee that Boston Private Wealth’s investment management services will achieve their objectives.
Investment products mentioned herein including stocks, bonds, and mutual funds may lose value and are not insured or guaranteed by Boston Private Wealth. Boston Private Bank & Trust Company or any affiliates or by the Federal Deposit Insurance Corporation or any other government agency. Past performance is not indicative of future results, which may vary.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.
Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates.
International investing involves unique risks, including foreign taxation, foreign currency fluctuation risks, risks related with possible variances in financial standards and other risks associated with potential political, social and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries.
In addition, concentration of investments in a single region may result in greater volatility. Due diligence processes seek to diminish, but cannot eliminate risk, nor do they imply low risk. Asset allocation, diversification and rebalancing do not guarantee a profit or protect against a loss in declining markets.
About Boston Private Wealth
Boston Private Wealth LLC (“BPW”), a registered investment adviser, offer investment management & consulting, wealth advisory and planning, and family office services as well as private banking and trust services in partnership with its parent company, Boston Private Bank & Trust Company (“BPBTC”).
BPW is a wholly-owned subsidiary of BPBTC, which is wholly-owned by Boston Private Financial Holdings, Inc. (NASDAQ: BPFH).
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