After many fits and starts this year, investors are now concluding that the elusive loosening of Federal Reserve monetary policy may be at hand. During the third quarter, a number of economic indicators, including the non-farm payroll unemployment rate, are showing signs that economic growth is slowing enough to arrest the fears of a potentially overheated and inflationary economy. The hope is that we enter a “goldilocks” economic phase, “not too hot and not too cold.” While the equity markets experienced a couple of bouts of volatility during the quarter, the popular broad indices are within shouting distance of all-time highs.
We are closely watching a couple of exogenous, albeit significant, overhangs for the financial markets in the near term. Currently, the upcoming presidential election is projected to be a close race. A disputed outcome may introduce some uncertainty regarding the peaceful transfer of power. That said, stocks have performed fairly well post-election in the last two presidential election cycles, despite the contentiousness of the outcomes.
The growing geopolitical uncertainties from the escalating conflicts in the Middle East and Ukraine are also of concern. One symptom of that uncertainty is manifested in the sharply rising price of gold so far this year. This suggests to us that the highly uncertain end game could cause market participants to react to any further escalation of violence. We believe our clients are well-served by having a healthy exposure to gold stocks, energy stocks and Treasury securities in the current environment.
Beyond the geopolitical concerns, we are mindful that equity valuations in aggregate are at historically high levels. Thus, we continue to focus new investments on equities and sectors that we believe are trading on the more modest end of historical valuations. By being more discriminating with regard to portfolio construction, we believe we can effectively play offense and defense simultaneously.
Is TINA Back?
Do you remember the popular acronym that became prevalent during the period of near zero interest rate policy of the early 2020’s? Many investors came to the conclusion that because interest rates were so low, the only viable strategy was to buy stocks. The slogan, “There Is No Alternative,” or TINA, became fashionable and led many investors to overweight equities in their portfolios. While that strategy worked well for a while, the bear market of 2022 resulted in losses that were perhaps exacerbated versus previous cycles when investors were more strictly adhering to prudent risk management principles.
As it now appears that interest rates have peaked, investors are beginning to believe that perhaps the “TINA” philosophy is becoming relevant again. To this idea we would offer some pushback. First, stocks are trading at historically high valuations based on a number of key metrics. Second, asset allocation should not be a function of the level of yields available. Rather, taking on equity risk needs to be commensurate with one’s financial objectives and risk tolerance. Finally, fixed income instruments are generally yielding more than the inflation rate, a feature that was not true in 2020-2021. Despite the decline in yields, one could say that bonds not only offer risk mitigation characteristics, but arguably still represent good value.
Bottom line: It is best to carefully consider the relative valuations of the entire universe of risk assets before falling in love with TINA once again!
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