Strong Economy, Expectations Boost Stocks but Pressure Bonds
U.S. equities generated further post-election gains last week on expectations that more fiscal
spending by the next administration will boost economic growth. Meanwhile, the U.S.
economy under the current administration continues to improve: Nearly every piece of
economic data reported recently has been better than expected—including initial jobless
claims, retail sales, housing starts and consumer confidence.
Positive earnings reports last week from retailers Target and Best Buy further reinforce that
consumer sentiment is strengthening, which bodes well for consumer-focused businesses
heading into the holiday season.
Internationally, Japan’s GDP growth in the third quarter (0.2%) handily beat expectations
thanks to strong exports driven by a weak currency. Other Asian nations, including the
Philippines and Hong Kong, also reported GDP growth that exceeded estimates. In Europe,
GDP growth met expectations while industrial production was better than expected due to
strength in nondurable consumer goods. Additional positive results recently include strong
retail sales in the UK and positive investor sentiment in Germany.
GAIN: Active Asset Allocation
Value stocks lead the way in the U.S. equity markets last week, driven by many investors’ view
that a December interest rate hike by the Federal Reserve is a near certainty. The energy and
financial services sectors, which are key segments of the value stock universe, both gained
Although developed international equity markets lagged the U.S. indices, emerging markets
stabilized and kept pace with the U.S. market. The relatively low valuations in emerging
markets have helped fuel increased flows of investment capital to these stocks.
In the fixed-income market, interest rates continued to rise along with higher inflation
expectations in the wake of the election results. We are avoiding longer duration bonds but
are maintaining a relatively large exposure to corporate securities–both investment grade
and high-yield–which we believe will benefit from a strong stock market.
PROTECT: Risk Assist
As global equity markets have continued to rally modestly, measures of expected future equity
market volatility have plummeted.
- The CBOE Volatility Index (VIX), which measures anticipated levels of volatility, has fallen to 13 from 22 in early November.
- Implied correlation (a measure of how expensive options on an entire index are relative to the price of options on the individual stocks in that index) dropped to around 0.30—an extremely low level, historically.
Bond yields have risen sharply, mostly as a function of modestly higher inflation
expectations. That development has caused interest rate-sensitive sectors which have
historically been considered “low volatility” sectors—such as utilities—to sell off. However,
we had forecasted that utility stocks would be meaningfully more volatile than they had
been historically, and shifted assets away from the sector as a result—a strategy that has
SPEND: Real Spend
Real Spend’s overweight to equities (relative to other retirement income strategies) has been
a positive as inflation expectations rise and the aggregate bond market sells off. As the new
administration begins to reveal its plans for economic growth and less accommodative monetary
policy, we expect these trends to continue.
Our equity focus is designed to mitigate both inflation risk and interest rate risk by seeking to
generate investment returns that outpace inflation and that are less sensitive to the direction of
rates. It may be valuable in the current environment to remember that we have done the research
to greatly simplify the quest for generating adequate retirement income. A retirement income
solution must be optimal across four dimensions:
- Duration of retirement
- Desired income during retirement
- Risk tolerance
- Portfolio allocation (e.g., equity/debt mix)
Real Spend has been designed with these dimensions in mind, with the goal of providing successful
portfolio allocations for long retirement durations.