Our current point of view on the Q1 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 coupled with decreased supply dynamics and overall lower interest rates has favored the group. However, forward return potential is muted 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 limited pockets of the taxable bond market still offer excess spread, the risk/return dynamic in broad bond indices, particularly for taxable investors, remains unattractive – yields are low and duration is elevated. We are especially avoiding corporate high yield bonds, where yields have fallen below 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
We have seen strong positive momentum in small/mid cap equities on the heels of vaccine announcements in November. Smaller, domestically-oriented companies will benefit as the U.S. economy reopens, however the recent rally 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 their historic averages. We believe a weaker U.S. dollar, the prior meaningful underperformance relative to the U.S., and a broader global recovery as the COVID health crisis abates will be supportive of international developed markets as the underperformance to the U.S. markets narrows.
The underperformance of Emerging Markets over the past decade has made valuations more attractive, considering that earnings growth has sustained. A weaker U.S. dollar and strong underlying demographic trends 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 gold and silver can provide a hedge to a weaker U.S. dollar as the monetary supply continues to expand.