Updated December 4, 2023
AJ Giannone, CFA
The S&P 500 closed last week at its highest level since March of 2022 in the wake of comments from Fed Chair Jerome Powell. Powell mentioned that the Fed policy rate is “well into restrictive territory” and that the risks were becoming more balanced. This provided a huge positive impulse for investors as they immediately bid up assets that had been the most negatively impacted by the Fed’s historically aggressive policy actions which have included raising the policy rate by 525 basis points and selling over $1 trillion of securities via open market operations.
Allio’s leading economic indicator index suggests an uncertain growth outlook for 2024. Early indicators of holiday spending are strong compared to earlier predictions of potentially weaker Q4 sales growth. However, the Atlanta Fed GDPNow estimate for Q4 real GDP growth has decreased from 1.8% to 1.2% as a result of weak construction spending data. We are therefore modifying our risk exposures in the portfolios as follows:
KRE (Regional Banks) - Today we’re initiating a new position in regional banks. Regional banks have suffered both earnings declines and balance sheet impairments as the Fed has pushed increasingly restrictive monetary policy. Their deposits have fled to money market funds, loan growth has stalled, and impairments to the market values of their securities portfolios have prompted questions about their solvency in the wake of the Silicon Valley Bank implosion. However, this theme seems to be mostly played out and looks set to potentially reverse as Fed policy normalizes. Additionally, sector-level price to tangible book value ratios are coming off historic lows. Together, these points are presenting an attractive entry point to build a position.
VDE (Energy) - Given that the rest of our tactical positioning is geared toward capitalizing on a normalization of monetary policy and a moderating outlook for growth, this new energy position should help balance the competing risks to inflation and growth moving forward. As energy prices have come down from their local September highs, VDE has recently found resistance on its 200-day moving average. We’re entering here looking for this level to hold and potentially provide a base to move higher if growth expectations surprise to the upside going forward.
VB (Small Cap) - Small cap equities have lagged behind their large cap counterparts throughout the recent rate hike cycle as worries around the lack of profitability and interest coverage ratios among the group have been punished by a market that was acutely focused on interest-rate sensitive risk factors. As we begin to look forward into 2024 for policy normalization from the Fed, we’re anticipating a continuation of the current relief rally.
FXI (China Large Cap Equity) - Investors continue to throw in the towel on Chinese equities (as reported by the Wall Street Journal last Friday), as continued weakness in the real estate market and active market intervention by the state investment fund caused jitters amongst investors. We’re cutting our losses here and waiting to see if a better and potentially more attractive entry point presents itself as the sell-off continues.
HYG (High Yield Corporate Bonds) - As risk-on sentiment returned in November, high yield spreads compressed from their local highs of 4.53% late October to close the month at 3.84%. While we still believe the yields are reasonable relative to the risks at these levels, we’re taking profit and looking to re-deploy these funds elsewhere while we wait for spreads to widen to more attractive levels.
EDV (Extended Duration Treasuries) - Similar to our high yield move above, we’re trimming our position based on the strong move lower in yields throughout the month of November. We continue to view the likelihood of policy normalization from here as a strong tailwind to long duration treasuries, but given the recent strength, we view our portfolio additions listed above as more compelling opportunities in the short term.
In summary, these portfolio adjustments are designed to strategically position our portfolios for the current environment headed into year end. We remain vigilant and adaptive, ensuring our strategies reflect both the current trends and the potential shifts in the market landscape going forward.
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