Still Invested, Perhaps More Vigilant

by: , Economist and Multi-Asset Portfolio Strategist, New York Life Investment Management; Robert Serenbetz, Portfolio Strategist, New York Life Investment Management; Multi-Asset Solutions team, Multi-Asset Solutions team, New York Life Investments

At the start of the year, it was easy to upgrade equities. The pace and scale of global equity market declines in Q4 departed significantly from the underlying economic data. Investors were overly bearish. We believed that these fears about a global slowdown were overdone.

Since then, global equity markets staged strong rebounds. The rally thus far has simply been an expected reversal in investor sentiment further supported by positive policy developments. Trade tensions eased, and the once-hawkish Fed has staged a 180-degree pivot in its communication with markets. With these market concerns clearing, the fog of uncertain economic policy should soon lift.

New York Life Investments’ Multi-Asset Solutions team published our 2019 Outlook update to share our detailed macroeconomic and asset class views. In this post, we focus on our high-level market takeaways for the remainder of the year.

Can equities continue to outperform?

Making a high conviction call is more difficult now than it was at start of the year. Valuations are about average, investor sentiment is mixed, and leading indicators of a growth pickup in the second half of the year need further confirmation. This leaves the risk-reward prospects for equities less clear.

In the near term, we expect that the late-cycle environment, lower liquidity, and higher volatility will give us more attractive entry points to add risk. Investors should focus on careful value plays – companies that trade at a discount and exhibit strong balance sheets, stable sales, or high return on investment.  Free cash flow generation is likely to be one of the strongest drivers of equity performance.

Fixed income, on the other hand, remains less attractive.

Fixed income fared better than we expected in Q1. A few bad data releases, lower growth forecasts, and Fed dovishness pushed some investors into safer government bonds. In Q1 the aggregate bond index increased 2.9%.

Looking ahead, the risk for bond investors is elevated. Markets are pricing a Federal Funds rate below the Fed’s own expectations. If growth accelerates in the second half of the year as we expect, and inflation expectations start to grind higher, the risk that interest rates and bond yields further out the curve rise is elevated.

The risk/return tradeoff in credit is also less than attractive. Healthy corporate profits and limited refinancing risk will keep defaults low by historical standards, but higher overall interest rates and profit margin pressure could cause defaults to rise modestly not too far down the road. As such, we don’t see investors in speculative grade debt as being particularly well rewarded for the risk they bear.

That said, fixed income is an important diversifier in investor portfolios. We believe investors should give up some yield in exchange for flexibility and safety. For example, we hold slightly shorter-term debt instruments and higher quality bonds than are contained in our benchmarks, and we look to generate income across a broad range of sources. Timing an impending credit cycle is extremely difficult, but we can prepare our portfolios to take advantage of the inevitable.

Equities are attractively valued relative to fixed income

Sources: New York Life Investments, S&P, Thomson Reuters DataStream, as of 4/22/19.

Our strategy for the remainder of 2019

Equity and fixed income investors appear to be pricing in different levels of risk. What are we to think?  At least through 2019, we are inclined to side with other equity investors.  Real rates are still quite low, consumer confidence is rebounding, household income continues to expand, and businesses continue to invest in themselves through capital expenditures and share buybacks.

Nevertheless, the late cycle environment raises stakes for investors who must be vigilant for signs the economic engine is finally running out of fuel. Tighter monetary policy, trade concerns, and the government shutdown have contributed to softer data readings. Slower economic growth – compounded by one-off effects of the anniversary of the new tax law – is likely to produce some weakness in the next few months, but conditions thereafter look favorable. Investors will need to be more precise about their risk budgeting and work harder for risk-adjusted returns than they have for most of the post-financial crisis period.

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

Definitions

The S&P 500 Index is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

The 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate once every six months, and pays the face value to the holder at maturity.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

New York Life Investments is a service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, New York, New York 10010, provides investment advisory products and services. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Lauren Goodwin, CFA

Economist and Multi-Asset Portfolio Strategist, New York Life Investment Management

Lauren Goodwin, CFA is an economist and multi-asset portfolio strategist with New York Life Investment Management’s Multi Asset Solutions (MAS) team, which has $10B in assets under management. She joined NYLIM in 2018 to focus on global macroeconomic trends

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Robert Serenbetz

Portfolio Strategist, New York Life Investment Management

Robert Serenbetz is the Portfolio Strategist with New York Life Investment Management’s Multi Asset Solutions (MAS) team. He contributes to investment thought leadership and communication efforts across New York Life Investment Management

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Multi-Asset Solutions team

Multi-Asset Solutions team, New York Life Investments

Multi-Asset Solution’s (MAS) is New York Life investments’ specialist in multi-asset investing.The team offers multi asset strategies, market intelligence, and customized solutions to its strategic partners. Managed assets include MainStay funds, strategic partnerships and customized solutions with third parties. Investment services include market insights, risk analysis, and financial education. Strategic partnerships are designed to meet bespoke investment objectives, such as income generation or inflation protection, through holistic solutions.

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