1. Favor Stocks Over Bonds, But Be Choosy
Stocks are still the preferred asset class.
The lackluster performance of U.S. stocks so far this year makes sense. Economic data have not met expectations, the strong dollar is hurting company earnings, and consumer spending is sluggish. Adding to these challenges, U.S. stock prices range from fully valued to expensive, especially relative to other developed markets.
But know this: Bonds are even more expensive, and that means stocks are still the preferred asset class. The trick (or the wisdom) is to be choosy. At this stage in the cycle (six years into a bull market) and in light of the economic backdrop, we would be cautious on segments of the U.S. stock market that are most affected when interest rates go up, such as utilities. Greater value can be found in sectors positioned to benefit from economic growth, such as technology and financials.
Key Takeaway: Stocks still look better than bonds, but seek out sectors offering relative value.
2. Look Overseas for Opportunities
Are you tapping into all the world markets have to offer?
This year has served as a reminder of why it makes sense to include international stocks in your portfolio. Through May, stocks in Europe and Japan had gained nearly 13% and 20%, respectively, while the U.S. was up just over 2% (all in local currency terms). Even emerging markets, which have lagged the U.S. for some time now, have outperformed the U.S. this year.
While it’s true that Europe is no longer cheap, and faces political challenges, and emerging markets remain volatile, we still expect them to notch decent performance relative to pricier U.S. equities. Europe and Japan, in particular, should also continue to benefit from market-friendly central bank easing. We have long been proponents of increasing international exposure, but even more so these days.
Key Takeaway: Dollar strength makes American goods expensive and less competitive overseas, dragging down earnings growth prospects for U.S. companies. The earnings picture looks brighter elsewhere.
3. Watch Your Step in Bonds
Not all bonds are created equal. Know what you own, and be flexible.
Navigating the fixed income markets remains challenging. The expected Fed rate hike has caused the yields on shorter-term bonds to rise in recent weeks. And although longer-term bond yields also have risen (and their prices dropped) recently, we still see few bargains for buyers of bonds.
We suggest looking to the high yield sector, which is typically less sensitive to rate movements, and to tax-exempt municipal bonds, which currently offer attractive yields—before and after tax. Most of all, income seekers must keep in mind that rates around most of the world will remain low for some time despite the Fed’s action, so flexibility and selectivity are critical in fixed income asset allocation.
Key Takeaway: Even though the Fed will raise rates, don’t expect abundant income opportunity in the short term. Income seekers should broaden their reach, but with a discerning eye in fixed income.
There are any number of reasons why investors may want to head for the exits: higher volatility, fears of a bubble, or concerns over what the Fed may do. In addition, we’re seeing episodes where stocks and bonds are moving more in sync as investors anticipate higher interest rates in the U.S.
Despite the temptation to abandon the markets, we believe the better strategy for long-term investors is to stay the course. Yes, adjust your portfolio to be better prepared for what lies ahead, and we’re not opposed to using some cash as an important ballast during times when stock and bond correlations are high. But overall, it is still preferable to weather volatility than attempt to time the ups and downs of the market.
Key Takeaway: Evidence shows that time in the market produces better results than trying to time the market.
5. Seek Growth in a Low-Growth World
Equip your portfolio with differentiated sources of risk and return.
What’s an investor to do in a slow-growth world where many traditional assets are looking pricey? Cast a wider net in pursuit of your financial goals. International stocks (including emerging markets), infrastructure or real estate can add growth to a portfolio. You might even consider alternative investments. These additions can help to diversify a portfolio while providing greater growth opportunities.
Diversification doesn’t guarantee profits or prevent loss (nothing does), but it does allow you to spread your risk across a broader set of instruments that may respond differently to a given set of market conditions. And in a world that still offers little in the way of screaming opportunities, mixing it up may be one of the best things you can do.
Key Takeaway: Expand beyond traditional assets in an effort to optimize your portfolio’s results.