Rates Rise, Oil Soars and Value Stocks Lead the Pack

U.S equity market is experiencing a rotation in leadership in the wake of the election. Based on expectations that the next administration will implement economic stimulus programs and increase spending, investors are shifting assets into economically-sensitive cyclical sectors (such as materials, industrials and energy) and away from those sectors whose performance is independent from economic growth (including technology and health care).

One effect of this shift: Value stocks, which tend to be more sensitive to economic conditions, have outperformed growth stocks by more than 5% in recent weeks.

Value Versus Growth, Post-Election

SOURCE MORNINGSTAR

In the fixed-income market, interest rates continue to rise on concerns that potential future economic stimulus programs from the government could fuel higher inflation. The rate increase has benefited the financial services sector, as financial firms tend to become more profitable as interest rate rise, while hurting interest-rate-sensitive sectors such as real estate and utilities. Meanwhile, the price of crude oil soared more than 12% last week after OPEC nations agreed to cut oil production—the first such move in eight years. Energy stocks rallied on the news, helping to further boost value stocks’ outperformance relative to growth shares.

GAIN: Active Asset Allocation
Equity markets consolidated some of their recent gains last week—not surprising, given that U.S. stock indices had generated three consecutive weeks of strong returns. International stocks have lagged the U.S. market, as uncertainty over trade policy under the next administration has increased uncertainty. Interest rates have continued to rise, as a growing number of investors see a rate hike by the Federal Reserve Board in December as a near certainty. The possibility of rising inflation going forward and the recent spike in oil prices will likely further boost that expectation.

The Gain portfolios are globally diversified, but at present have more exposure to the U.S. than do most global indices. This diminished international focus in our equity portfolios’ current allocations has generally proven beneficial in recent weeks.
income portfolios remain overweight in both corporate bonds and preferred equities. With interest rates potentially rising, we prefer to take on additional preferred equity exposure rather than interest-rate risk.

PROTECT: Risk Assist
All gauges of equity market risk eased during the past week, including the VIX, the VIX term structure, implied correlations and volatility skew. However, most measures of interest rate risk or currency risk—such as rate skew and swaption implied volatility—rose during that time.

We have positioned the Risk Assist portfolios to be less exposed to the currency and interest rates risks that have begun to materialize. For example, we are emphasizing small-cap stocks, which do not have the currency sensitivity found among large-cap stocks. We also are broadly diversified in our international allocations.

SPEND: Real Spend
Post-election, inflation risk and interest-rate risk have risen significantly. The yield on the 10-year Treasury note is up more than 60 basis points, and inflation expectations rose by more than 25 basis points in November alone.

Of course, yield-focused investments are typically hypersensitive to these types of risks, and can produce unstable levels of income while also sacrificing long-term investment growth potential. Real Spend seeks to generate stable income and deliver stronger performance than yield-focused investments during periods of heightened inflation and interest rate risk. Real Spend also emphasizes equities in an effort to balance current income needs with growth of capital over time.