be_ixf;ym_201911 d_16; ct_150

Taking Chips off the Table

February 22, 2017  | by Ryan Driscoll, Michael Strauss

Equities | Fixed Income | Market Commentary

Summary

  • For the last several years we have maintained a bullish stance towards equities, favoring an overweight to U.S. stocks. In line with this view, the S&P 500 Index has staged a solid multi-year rally from about 1260 at the start of 2012 to 2365 on February 21, 2017.

  • We began this year forecasting that the S&P 500 Index would rally to 2425 and, with the strong performance since the start of 2017, U.S. equities have already “earned” more than 50 percent of our projected annual return in just seven weeks.

  • Near term, we may see a return to a choppy market where stocks still best bonds but with a smaller differential. Accordingly, the time may be right to take a step back from the recent euphoria to reassess and, if necessary, rebalance portfolios.

The question we are often asked is…when should investors begin to take chips off the table?

The S&P 500 Index has delivered a 16 percentage point relative gain compared to the Bloomberg Barclays Aggregate Bond Index since the start of this fiscal year. What’s more, with stocks having tallied more than a 30 percentage point relative advance to bonds since the low close in February 2016, we believe the time to consider taking gains is upon us. Institutions should revisit, reconfirm, and if necessary, rebalance their portfolio asset allocation to ensure they maintain their policy risk and return targets. This could consist of harvesting a portion of the strong returns from equities in recent months and years. We still favor an overweight to equities and an underweight to fixed income and duration, but we recognize that in order to hit our 2425 year-end target the S&P 500 Index will need to post a gain of less than 60 points (or just 2.5 percent from price appreciation). This could unfold with some backing and filling via a return to a two-way market, rather than the “runaway freight-train” rally we have seen for the last 13 months.

A better economy, but with moderate inflation

We still believe that the economy will work its way toward stronger 2.8 percent growth later this year, with fiscal stimulus likely to provide an added boost to both economic activity and after-tax corporate profits. We remain encouraged by the rebound towards 2.5 percent real growth in the second half of 2016 and the associated improvement in corporate earnings. However, the current euphoria in the stock market may be a bit ahead of the facts. A return to the residual seasonality distortion for real GDP may again occur in 2017:Q1 and produce a temporarily softer real GDP print, as has been the case for most first quarters over the last two decades. This, combined with a rebound in inflation in 2017 and some stumbling blocks from our new Administration, may create indigestion for the capital markets near term, especially if the Fed steps up the pace for normalizing interest rates.

The latest CPI report provides another sign that inflation has bottomed. The consumer price index rose 0.6 percent in January to a 2.5 percent year-over-year pace, with a 4.0 percent surge in energy prices providing the greatest boost to inflation. Moreover, core consumer prices rose 0.3 percent last month, boosting its yearly gain to 2.3 percent. Service costs, the largest core and total CPI component, continued to run hotter than the Fed’s two percent inflation target as the yearly gain in January was 3.1 percent, above the yearly range for the last 12 months.

The Fed is in play

For the Fed, recent data are yet another example that the current funds rate is still overly accommodative relative to inflation and the pace of economic activity. The improvement in domestic economic activity, combined with signs that inflation has bottomed and greater prospects for fiscal policy stimulus, has increased the likelihood that the Fed will take additional steps to neutralize the funds rate later this year, possibly as early as the mid-March FOMC meeting.

Fed Chair Yellen recently gave her first semi-annual monetary policy presentation to the new Congress. Her mission included keeping the possibility of a March rate hike on the table. She stressed that “waiting too long to remove accommodation would be unwise” and emphasized that “at our upcoming meetings, the Committee will evaluate whether employment and inflation are continuing to evolve in line with [our] expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” Her comments suggest that the Fed is still likely to implement three normalization rate hikes this year. Such action could put downward pressure on Treasury prices and place headwinds on the stock market.

Hence, taking chips off the table and locking in a portion of the favorable equity performance in the first eight months of this fiscal year should make it easier to sail in what is likely to be choppy waters this spring.

Authors

X
Ryan Driscoll is a member of the Commonfund Asset Management Investment team and is primarily responsible for investment monitoring, rebalancing and reporting for investment portfolios with a focus on operating assets. Prior to joining Commonfund, Ryan worked at Sailfish Capital Partners, a multi-strategy fixed income fund, where he served on the Emerging Markets team. Prior to that, he was on the fixed income team at Grantham, Mayo, Van Otterloo & Co. and was an equity/fixed income trader at Loring, Wolcott and Coolidge, in Boston. Ryan received his B.S. in Finance and M.S. in Global Financial Analysis (with Distinction) from Bentley University. He is a CFA Charterholder and is a member of the Boston Securities Analyst Society and CFA Institute.
Ryan Driscoll
Director, CFA

Subscribe & Manage Your Frequency to Insights Blog

Stay up-to-date with the latest information with our Insights Blog. Topics covered included:

  • Asset allocation

  • Governance and policy

  • Industry knowledge

  • Market commentary

  • Outsourced investing

  • Risk management

  • Responsible investing

Sign up now to stay informed.

Already signed up? Change your subscription frequency here.



Fill in your details below


Notification Frequency


Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.