Goldilocks’ Year

by: , Portfolio Strategist, New York Life Investment Management

The Goldilocks investment environment may be coming to an end. What does that mean for portfolios?

The Backdrop

Everyone knows the famous story of Goldilocks. A little girl goes for a walk in the forest and enters a home where she finds three bowls of porridge. The first bowl is too hot, the second too cold, but the third one is just right, so she eats it all up.

In 2017, similarly, investors found themselves in an environment that was ‘just right’. Global synchronized growth took hold. Nearly every economy grew, some at its fastest pace since the financial crisis, while others exited recessions. Despite the dramatically improved economic environment, inflation remained non-existent. So, despite record-low interest rates, central banks could maintain their dovish tone – with some even cutting rates.

Risk assets certainly benefited. The 10-Year Treasury traded between 2% and 2.6%1 – a very narrow range. Stocks returned 21.8% with the second lowest volatility on record.2 The S&P 500 declined by more than 1% on only eight occasions. In the end, it was one of the highest quality years on record. Bonds and stocks worked together, with a low risk of shock.

Too Hot?

A too-hot economy is hard to characterize. It exhibits many qualities – more economic activity, more hiring, and more strain are among them, but the recent rise in inflation visible in wages and CPI is most telling.

Signs Inflation (and the Economy) May Be Approaching a Boil:

  1. U.S. economy near full employment
  2. Productivity growth low
  3. A cheap dollar
  4. Global output gap rapidly closing
  5. Even more fiscal stimulus in the pipeline

Inflation Is Bad for Both Stocks and Bonds

Inflation erodes the purchasing power of a bond’s future cash flow. Therefore, when inflation expectations rise, investors require a greater yield for their investment. Any rise in inflation is bad for bonds.

Equities are less impacted, at first, by inflation. Inflation increases a firm’s cost to borrow (as the Fed raises rates), while also reducing the future value of earnings in today’s dollars. For now, a little inflation is okay for stocks, but as inflation rises significantly investors may be less willing to pay today’s prices for tomorrow’s (less valuable) earnings.

If inflation concerns continue to linger, we may be entering a period where both stocks and bonds move together. These scenarios reduce the effectiveness of a diversified portfolio of stocks and bonds and can be very painful for investors.

Bottom Line

Inflation remains at moderate levels, the economy remains on very solid footing, and earnings are in an upward trend. As such, we prefer equities to fixed income. We recognize that the end of Goldilocks likely means more inflation and more volatility. Investors concerned about the regime change may want to consider adding alternative investments or commodities to their portfolio where appropriate.

1. Based on the 10-Year U.S. Treasury Yield, 12/31/16 – 12/30/17.

2. Based on the S&P 500 Total Return Index, 12/31/16 – 12/30/17

The information and opinions contained herein are for general information use only. MainStay Investments does not guarantee their accuracy or completeness, nor does MainStay Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are as of the date of this report, are subject to change without notice, and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in this material will be realized.

About Risk

All investments are subject to market risk, including possible loss of principal. Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments. Bonds are also subject to credit risk, in which the bond issuer may fail to pay interest and principal in a timely manner, or that negative perception of the issuer’s ability to make such payments may cause the price of that bond to decline. A bond’s prices are inversely affected by interest rates. The price will go up when interest rates fall and go down as interest rates rise.

Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.

Alternative investments are speculative, not suitable for all clients, and intended for experienced and sophisticated investors who are willing to bear the high economic risks of the investment.

Commodity: Investments in instruments and companies that are susceptible to fluctuations in certain commodity markets. Any negative changes in commodity markets (that may be due to changes in supply and demand for commodities, market S-4 events, regulatory developments or other factors) could have an adverse impact on those companies.

Index performance is shown for illustrative purposes only and does not predict or depict the performance of the Funds. Indices are unmanaged, include the reinvestment of dividends, and cannot be purchased directly by investors. Past performance does not guarantee future results.
The S&P 500 Index is an unmanaged index and is widely regarded as the standard for measuring large-cap U.S. stock-market performance. Index results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index.

The Standard & Poor’s 500 Index (S&P 500) is one example of a total return index. The total return indexes follow a similar pattern in which many mutual funds operate, where all resulting cash payouts are automatically reinvested back into the fund itself.

MainStay Investments® is a registered service mark and name under which New York Life Investment Management LLC does business. MainStay Investments, an indirect subsidiary of New York Life Insurance Company, New York, NY 10010, provides investment advisory products and services. Securities distributed by NYLIFE Distributors LLC, 30 Hudson Street, Jersey City, NJ 07302.

1767153

Robert Serenbetz

Portfolio Strategist, New York Life Investment Management

Robert Serenbetz is the Portfolio Strategist with New York Life Investment Management’s Strategic Asset Allocation & Solutions (SAS) Group. He contributes to investment thought leadership and communication efforts across New York Life Investment Management

Full Bio

2 Comments

Leave a Reply

Your e-mail address will not be published.