Our current point of view on the Q3 2021 markets, which we share with clients, peers and the industry
“This roadmap informs our portfolio design. As markets shift, we reflect and adjust.”
— Alex Bass, Chief Investment Officer
Tax-exempt bonds serve the purpose of providing capital stability and the tax-free income particularly relative to taxable bonds continues to be valuable for investors in high-tax states. Strong demand in anticipation of higher tax rates, coupled with decreased supply has favored the asset class. However, forward return potential is limited given the historically low-rate environment. As the role of municipal bonds is reduced to capital preservation, a focus on credit quality is paramount.
While a few segments of the taxable bond market still offer excess spread, the risk/return dynamic in broad bond indices, especially for taxable investors, remains unattractive – yields are low and duration is elevated. We are especially avoiding corporate high yield bonds, where yields have fallen to 4% and do not offer sufficient compensation should the credit environment deteriorate.
US Large Cap
The continuing accommodative monetary policy and additional fiscal stimulus will provide support to the equity markets this year. Increased vaccine rollout paves the path for a broader economic recovery, one that should see cyclical and value stocks continue to gain ground on growth stocks. Our Neutral stance on equities is driven by the current valuation, however we would look to take advantage of periods of market weakness to add exposure, favoring more cyclical and value equities.
US Small / Mid Cap
Smaller, domestically-oriented companies will benefit as the U.S. economy reopens, however the rally this year particularly in small cap value equities is reflective of optimistic expectations. Additionally, as companies in this market segment generally have higher leverage levels and lower profitability, sector and security selection is important and supports an active management approach.
Developed international markets are trading at a more attractive valuation relative to the U.S. and a smaller premium relative to their long-term average valuations. We believe that a broader global recovery as the COVID health crisis abates will be supportive of international developed markets and we will see the prior underperformance to the U.S. markets reverse course.
The underperformance of Emerging Markets over the past decade has made valuations more attractive, considering that earnings growth has sustained. Strong underlying demographic trends and the continuing maturation of the emerging market economies should benefit performance. Given the volatility in the asset class, we look to size the allocation to emerging markets appropriately for the specified client risk tolerance.
Alternative Investments encompass a wide range of strategies. Our focus remains on identifying those which can benefit the portfolio through diversification (healthcare royalties), increased cash flows (direct lending, real estate), or by taking on idiosyncratic risks (growth equity). Additionally, real assets such as precious metals and diversified commodities can provide a hedge to a weaker U.S. dollar should inflation surprise to the upside.
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