Balancing Act: Opportunities and Risks for Investors
Markets do not change on a regularly scheduled calendar basis; they change at a moment's notice. By having a dynamic approach to allocate capital between equities and fixed income, an investment team can be responsive to changing market conditions to balance opportunities and risks. Collaboration between equity and fixed income portfolio managers and analysts, working together to evaluate companies holistically to balance the opportunities and risks, can be a powerful driver to compounding capital for investors.
Currently, drivers to stay overweight equities in a balanced strategy with a positive view on the market for 2022 include strong consumer balance sheets, labor growth making progress, and strong wage growth to support consumer spending. Additionally, record consumer wealth following a strong equity market and home price appreciation in 2021 should all help drive strong consumer spending in 2022. A positive outlook on capital spending because corporate balance sheets are in strong shape is supportive of risk-assets too, and there are many catalysts to drive the capital spending such as IT spending, cloud, and semi-conductor business. We continue to see bright outlook for earnings growth – reinforcing that view is that many companies are raising dividends at impressive levels and continuing with strong share buyback programs.
While navigating a shift in central bank policy is never straightforward, bonds can also continue to offer opportunities to add value in the coming quarters while maintaining their traditional role as a diversifier in volatile times. While inflation is likely to remain elevated, we believe it will trend lower from the recent year-over-year peak. We believe that the yield curve could continue to flatten with the front-end moving up with Fed rate hikes to combat inflation, while the back-end may rise more slowly as markets question longer-term growth prospects. With that, it’s natural to expect some volatility in markets which could allow for some opportunity to add corporate credit during the year after spreads tightened close to record levels in 2021, making valuations quite rich. Additional opportunities that could help mitigate the impact of rising rates include floating rate securities, and securitized products such as CMBS, ABS, and CMOs. Finally, maintaining a duration shorter than the index is important to mitigating the impact of rising rates too.
As we navigate periods with the potential for heightened volatility and some degree of rising interest rates, we continue to believe in the importance of balancing the opportunities and risks between equities and fixed income.