Investors Hit Pause, Seek Clarity from the Fed

The recent rally that has driven global equities to their highest levels in a year slowed last week. Investors largely sat on the sidelines as they waited to hear what Federal Reserve Board Chairman Janet Yellen would say about the U.S. economy and future Fed monetary policy during a major speech given at the end of the week. In her speech, Yellen noted that “the case for an increase in the federal funds rate has strengthened in recent months,” but that any interest rate decision “always depends on the degree to which incoming data continues to confirm the Fed policy committee’s outlook.” While Yellen’s comments make a September rate hike a firm possibility, future rate increases may come at a slower pace than previously imagined due to uncertainty around inflation expectations.   

Investors increasingly believe that the Fed may move to raise short-term interest rates soon, possibly in September or December (but most likely not in both of those months). Recent comments from various Fed members have sounded somewhat “hawkish”—meaning they seem to favor a near-term rate hike—as the U.S. labor market nears full employment and inflation slowly rises towards the central bank’s target. As such, the probability of a U.S. rate hike in September (as measured by futures prices) rose to 28 percent from 24 percent at the start of last week, while the chances of a rate hike by the end of the year increased to 54 percent.

GAIN: Active Asset Allocation

Market activity remained slow, as investors waited for comments from Fed Chairman Janet Yellen during a speech late in the week. The lack of clear direction from the Fed, coupled with choppy economic data, have the financial markets in neutral for the moment.

Small-cap stocks and developed international markets were relatively strong as U.S. large-cap stocks and emerging markets paused from their recent rallies. Meanwhile, corporate bonds, high-yield bonds and preferred stocks remained attractive. As long as markets are stable and companies’ balance sheets are healthy, we will remain positive on corporate fixed-income securities.

PROTECT: Risk Assist

Global equities sputtered last week and, as we expected, volatility began to rise. The CBOE Volatility Index (VIX), which measures expected future levels of volatility, rose to around 14, up from 11 earlier in the week as investors took slightly more “risk off” positions. It was a relatively low-volume week, overall, as most investors waited to see what Yellen would say about the economy during her speech on Friday. Leading up to the speech, interest rates and the U.S. dollar were relatively static.

SPEND: Real Spend

Overall, volatility began creeping back into the market last week. That said, equity volatility remains flat over the past two weeks versus over the past month. Fixed-income volatility has fallen during the past two weeks relative to one-month levels. The aggregate bond market, municipal bonds and preferred stocks have been beneficial contributors to performance.

We believe Real Spend’s emphasis on both equity and fixed-income investments remains a better approach for retirement-focused investors than does an all-bonds strategy. Consider that:

  • Real, inflation-adjusted returns for a 60% stock/40% bond portfolio* have never been negative over rolling 20-year periods looking back all the way to 1926. However, adjusting for inflation, a 100% bond portfolio could have delivered returns as low as -36% during one 20 year stretch in that same time period.
  • Over 30-year rolling periods going back to 1926, the worst inflation-adjusted return for a 100% bond portfolio was –30%.The worst such return for a 60/40 portfolio: +145%.

*S&P 500/Intermediate-term government bonds (measured quarterly)

 

Categories: Market Notes
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