Executive Summary
- Sticky inflation has complicated the outlook for our economy and markets. It is likely that the Fed will need to hold rates at this level for longer than previously expected.
- While our economy remains resilient it is not immune to monetary tightness. We continue to see signs of strain among pockets of consumers and businesses and expect they will increase with time.
- It is a two speed economy with many smaller businesses and lower income consumers hurting while larger companies and higher income consumers have maintained their spending power.
Fixed Income
Weight: Neutral
Interest rates remain at levels not seen since before the Great Financial Crisis. While inflation has become sticky, interest rates remain above the rate of inflation. The combination of these two factors are likely to translate into higher returns on an absolute and inflation adjusted basis.
U.S. Taxable Investment Grade
Weight: Neutral
After a rise in interest rates to date, we see a more balanced picture for longer duration investment grade debt, and potentially some upside should the economy slow as we anticipate.
Duration
Weight: Slight Overweight
Higher than expected inflation readings have caused interest rates to move up across the curve. We are considering adding to duration should rates move even higher
U.S. Taxable Non-Investment Grade
Weight: Neutral
HY bonds have performed well in the face of higher interest rates due to economic resilience, lower maturity wall, and higher index quality characteristics. We would be overweight if credit spreads were wider.
Equities
Weight: Neutral
After a strong run to date we see the equity outlook as more balanced with potential slowing economic growth offset by an expected easing pivot in monetary policy.
U.S. Large Cap
Weight: Neutral
Earnings for large caps continue to surprise to the upside and estimates for 2024 have begun to rise. Admittedly, earnings are still being driven by a small contingent of mega-cap companies and has yet to broaden out.
Growth
Weight: Slight Underweight
Growth stock outperformance has resumed with strong outperformance of mega-cap stocks. Narrow leadership is typically not a healthy sign, though there has been earnings support behind the move.
Value
Weight: Slight Overweight
We believe the opportunity for Value outperformance should improve as we move toward 2025 given attractive relative valuations. Slowing economic growth does provide a near-term headwind, though is likely needed for inflation to slow and the Fed to pivot.
U.S. Mid Cap
Weight: Modest Overweight
Mid-cap valuations are significantly below average on a historical basis versus their own history and relative to large caps. Mid-caps underperformed large caps despite stronger earnings growth over the past two years.
U.S. Small Cap
Weight: Neutral
Given the likelihood of a more extended Fed rate pause, we decided to remove our overweight to this more economically sensitive asset class. We see this as a near-term risk.
International Developed
Weight: Slight Underweight
We see an opportunity developing for international developed stocks mainly due to the timing difference between US and European central banks. Later this year Europe's economy could begin to improve while the US is slowing.
International Emerging
Weight: Neutral
The emerging market picture remains mixed, both from an economic standpoint as well as valuations. Given an extended Fed rate pause we are less confident in the return prospects for many developing markets in the near-term.
Strategic: Strategic asset allocation is a baseline allocation between asset classes established with a longer term focus and congruent with an investor’s investment goals and objectives. The allocation is meant to optimize the asset mix through methodical diversification in an attempt to maximize return and lessen risk.
Tactical: Tactical asset allocation is differentiated from strategic asset allocation by having a much shorter time horizon and the goal of adding alpha beyond what would be allowed through static strategic weights. Markets tend to be more volatile over shorter time horizons, while longer time frames tend to smooth out that volatility. That enhanced volatility in the short term creates the opportunity for either return enhancement and/or risk reduction by adding to or reducing weights of different asset classes.