Trimming Equity Exposure
While risk-taking remains in fashion and more stimulus is on the way, we are trimming back some equity exposure. We now forecast some tempering in the outlook ahead (Chart A, below) after a long stretch of improving conditions. As a result, we reduced stock exposure to 67% from 80% and increased bond exposure to 33% from 20%. CONQUEST tactical asset portfolios remain overweight stocks versus bonds, only less so.
Chart A
WCA Fundamental Conditions Barometer
High Hopes
Since the governments and central banks around the world went “all-in” to save the economy from the pandemic last spring, wealth has exploded. The value of global stocks rose to $103 trillion from $70 trillion last March for a $33 trillion gain. About half the increase came from government stimulus-response last spring and summer, and the other half came as vaccinations began.
The return of risk appetite drove all markets, not just stocks. Credit spreads fell back to pre-pandemic levels (implying investors are unconcerned about defaults), the Treasury curve is the steepest it’s been in three years (implying investors see growth ahead), and long-run inflation expectations priced in to bonds are now above the Federal Reserve’s elusive 2% “goal.” Finally, expected year-ahead earnings for the S&P 500 have recovered from their swoon last spring.
“There is no stress here, and only growth ahead!” markets seem to cry valuations reach new highs.
Employment Progress Hits a Wall
While financial markets plow ahead in anticipation of returning growth, last week’s employment report gives us some reason for pause. The rapid improvement in jobs from last April to October hit a wall over the November-January period. The three-month average level of monthly job additions plunged to a miniscule 28,000. To put this in perspective, the average level of monthly job additions from 2010-2020 (before COVID-19) was 140,000. As of October, the rate was close to 1 million per month.
Keep in mind that, at current levels, employment remains very far below where pre-pandemic trends say we should be (Chart B, below). The graph clearly illustrates what it might look like if employment gains get stuck at the current growth rate. A 15 million jobs “gap” has opened up between current levels and where we should be based upon pre-pandemic trends. Without a revitalized jobs engine, chronic excess capacity could result, possibly leading to downward pressure on wages, prices, and demand. We believe this is a major motivation behind renewed efforts to advance another round of stimulus and a huge incentive to accelerate vaccinations.
Chart B
United States Employment Trends
Tail Meets Dog
Ultimately, stock valuations and interest rates are determined by economic performance. That markets are discounting near-certain continued growth is evidenced by sizable gains in most financial markets. Should questions emerge about the pace of economic improvement, such as we are seeing in the jobs data, the bull case could be challenged. There is little room for disappointment given the run-up in stock prices, tightening of credit spreads, and steepening of the yield curve. Six or nine months ago, there was plenty of room for improving expectations, but now those expectations need to be met. It seems the “dog has caught its tail” as markets have run ahead of the economy in anticipation of full recovery.
Tactical Posture
Here is a summary of WCA’s top-down tactical positioning:
- Stocks vs. Bonds: Overweight Equities vs. Bonds
- Global Stocks: Overweight Foreign vs. Domestic
- Stage of Development: Overweight Developed vs. Emerging
- Equity Style: Overweight Value vs. Growth
- Credit Quality: Overweight Investment Grade vs. High Yield
- Bond Duration: Overweight Short vs. Long Duration
- Other: Overweight REITs and Neutral Gold
For our 2021 Viewpoint report, which discusses these views in greater depth, please click here.
To learn about WCA’s tactical asset allocation program, please click here.
Disclosures:
WCA Barometer – We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. Analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
Standard & Poor’s 500 Index (S&P 500) is a capitalization-weighted index that is generally considered representative of the U.S. large capitalization market.
The S&P 500 Equal Weight Index is the equal-weight version of the widely regarded Standard & Poor’s 500 Index, which is generally considered representative of the U.S. large capitalization market. The index has the same constituents as the capitalization-weighted S&P 500, but each company in the index is allocated a fixed weight of 0.20% at each quarterly rebalancing.
The Washington Crossing Advisors’ High Quality Index and Low Quality Index are objective, quantitative measures designed to identify quality in the top 1,000 U.S. companies. Ranked by fundamental factors, WCA grades companies from “A” (top quintile) to “F” (bottom quintile). Factors include debt relative to equity, asset profitability, and consistency in performance. Companies with lower debt, higher profitability, and greater consistency earn higher grades. These indices are reconstituted annually and rebalanced daily. For informational purposes only, and WCA Quality Grade indices do not reflect the performance of any WCA investment strategy.
The information contained herein has been prepared from sources believed to be reliable but is not guaranteed by us and is not a complete summary or statement of all available data, nor is it considered an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. There is no guarantee that the figures or opinions forecast in this report will be realized or achieved. Employees of Stifel, Nicolaus & Company, Incorporated or its affiliates may, at times, release written or oral commentary, technical analysis, or trading strategies that differ from the opinions expressed within. Past performance is no guarantee of future results. Indices are unmanaged, and you cannot invest directly in an index.
Asset allocation and diversification do not ensure a profit and may not protect against loss. There are special considerations associated with international investing, including the risk of currency fluctuations and political and economic events. Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments. Investing in emerging markets may involve greater risk and volatility than investing in more developed countries. Due to their narrow focus, sector-based investments typically exhibit greater volatility. Small-company stocks are typically more volatile and carry additional risks since smaller companies generally are not as well established as larger companies. Property values can fall due to environmental, economic, or other reasons, and changes in interest rates can negatively impact the performance of real estate companies. When investing in bonds, it is important to note that as interest rates rise, bond prices will fall. High-yield bonds have greater credit risk than higher-quality bonds. Bond laddering does not assure a profit or protect against loss in a declining market. The risk of loss in trading commodities and futures can be substantial. You should therefore carefully consider whether such trading is suitable for you in light of your financial condition. The high degree of leverage that is often obtainable in commodity trading can work against you as well as for you. The use of leverage can lead to large losses as well as gains. Changes in market conditions or a company’s financial condition may impact a company’s ability to continue to pay dividends, and companies may also choose to discontinue dividend payments.
All investments involve risk, including loss of principal, and there is no guarantee that investment objectives will be met. It is important to review your investment objectives, risk tolerance, and liquidity needs before choosing an investment style or manager. Equity investments are subject generally to market, market sector, market liquidity, issuer, and investment style risks, among other factors to varying degrees. Fixed Income investments are subject to market, market liquidity, issuer, investment style, interest rate, credit quality, and call risks, among other factors to varying degrees.
This commentary often expresses opinions about the direction of market, investment sector, and other trends. The opinions should not be considered predictions of future results. The information contained in this report is based on sources believed to be reliable, but is not guaranteed and not necessarily complete.
The securities discussed in this material were selected due to recent changes in the strategies. This selection criterion is not based on any measurement of performance of the underlying security.
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