Looking Ahead - Q4 2017
- Credit & Lending
- Financial Planning
The third quarter of 2017 presented many of the same issues experienced in the first half of 2017. Continued inaction by Congress on a replacement for — or repeal of — Obamacare, escalating tensions with North Korea, and more changes in the leadership team of the Trump Administration once again proved little match for the combination of low unemployment, low inflation, and an economy that while not great, is pretty good. Sprinkle in September’s tax cut proposal and no indications of seasonal softness, and lofty valuations appeared almost palatable.
Driving the global equity market, too, is the acknowledgment that bonds still appear an inferior substitute to stocks, given their low yields and the grind higher in rates that is likely to occur over the next several years. In addition, expectations for U.S. fiscal stimulus have managed to persist, and along with them an eye towards +3% GDP growth, which could be the catalyst to sustain the current bull market in the U.S. Combine this with the opportunities in international developed and emerging markets stocks, and we believe that an overweight position in equities is appropriate.
With that said, for U.S. equities, our portfolios remain positioned with an eye towards higher rates and reflation. Our team has been moving more underweight to areas such as consumer staples and utilities in favor of pro-cyclical areas such as financials and industrials. While the team acknowledges the potential positive impacts from the President’s proposed corporate tax cut, we are not buying companies based purely on their current tax rate, but rather looking to benefit from the trends mentioned above. Our portfolio managers like technology stocks as well, as they could benefit from repatriation and still represent the areas of continued growth within the global economy. We are also being selective in the energy space, looking for companies for which the stock price has not yet reflected the higher, stabilized prices in the commodity markets.
Our team remains confident in international equities, despite the influx of flows into the space and the strong returns for these stocks experienced so far this year. While the sovereign debt crisis was concentrated in the periphery markets of the European Union, the fallout from it spread to the core markets as well, but those were the first to recover post-crisis. The breadth of the recovery has improved, and it is no longer just Germany driving improvements in areas like manufacturing and employment. In addition, low interest rates and inflation are translating to stronger business investment and higher levels of domestic consumption, which benefit both small and large companies. In Japan, government stability has provided a platform for concerted fiscal and monetary policy, and although demographic headwinds persist, there is a strong catalyst to break out of the perpetual deflationary cycle which has plagued the nation. We remain positive on emerging markets equities as well, particularly as the U.S. dollar remains somewhat range bound, weakening this year even as interest rates moved higher. While a weaker dollar is certainly a catalyst for additional emerging markets gains, we are also optimistic on recent data from China indicating a tick up in industrial activity, as well as the stabilization in oil prices which benefits Brazil and Russia.
As noted above, we remain underweight bonds versus equities. Within our taxable bond portfolios, the team continues to favor corporate bonds, given the underlying strength of the economy and overall corporate balance sheet health. From a duration standpoint, our corporate bond portfolios are slightly shorter than the relevant benchmarks, but our team expects duration to lengthen modestly towards neutral in the fourth quarter. In addition, the team has been selecting lower quality credits as appropriate to add yield. For 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 better quality credits, instead earning additional yield by adding callable bonds to portfolios.
Finally, oil prices have stabilized and provided a level of support for commodity investors as a result. Precious and industrial metals have traded higher and could continue to benefit from potential reflation should current trends persist. We remain allocated to broad commodities, but we are watching the space closely as we near the end of the year. REITs have held up fairly well against a backdrop of rising interest rates. We remain underweight the sector, and favor global exposure over dedicated U.S. exposure at this time.
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