Is Too Much Optimism Priced Into Risk Markets?
March 28, 2017 By Sage Advisory
Macro conditions have continued their positive trajectory throughout the first quarter of the year, with US economic activity at the highest pace post-crisis and the labor market showing healthy job creation and wage growth. Meanwhile, global inflation is increasing and downside risks have largely subsided.
Markets are responding with a strong rally in equity markets, higher bond yields, and tighter credit spreads. With this abundant optimism, we would caution against over-bullishness given the fact that current sentiment is largely reflected in current prices.
Risk assets may be prone to bouts of policy-related volatility as the new administration works to implement fiscal stimulus and the Fed tightens monetary policy in response to financial conditions.
Finding Opportunities in Fixed Income
After a sharp spike higher in the fourth quarter of 2016, yields have been largely range-bound this year. The Fed’s forward guidance on rate hikes, coupled with an uptick in inflation data, means that yields could drift modestly higher over the next two quarters. However, we continue to believe that strong global demand for US fixed income will balance tighter monetary policy, keeping rates contained.
Within our asset allocation strategies, we are slightly short duration, maintain an overweight to credit, and hold an allocation to both preferreds and bank loans. Additionally, we recently increased an allocation to TIPS, which look attractive when compared to traditional measures of inflation, including core CPI and wages.
International Equities Show Promise
We continue to be constructive on equities and remain focused on relative value opportunities, holding an overweight to core international markets, which are attractive from a valuation perspective when compared to US equities. We believe developed international equities will benefit from global reflationary trends, weaker currencies, and still favorable monetary policies relative to the US.
As we move towards year-end, policy and politics will continue to dominate the conversation. As optimism wanes, volatility will most likely increase. The best way to weather volatility is by maintaining a sound risk management discipline rooted in relative valuation and fundamental analysis.
For more insight, please visit our Asset Allocation or reach out to the team at 512-895-4130.
Sage Advisory Services, Ltd. Co. is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. This report is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results. For additional information on Sage and its investment management services, please view our web site at www.sageadvisory.com, or refer to our Form ADV, which is available upon request by calling 512.327.5530.