As the economy continues to slowly come back, and we continue to see an increase in discretionary spending, we will maintain our strong position in the cyclical stocks that will benefit from a long term recovery. We will also recognize the need to reduce equity exposure to companies that have reached full value or in some cases are well above value and reduce exposure short term uncertainty.
Move to neutral across US and Developed Market equities, unwinding our long-held US overweight and DM underweight positions based on recent relative strength of DM corporate earnings estimate revisions and earnings surprises.
We will continue to find the strategy of a barbell exposure to value and growth (an even allocation of value and growth stocks) as an attractive risk/reward opportunity and further extend this theme by adding to momentum and introducing more direct exposure to DM value stocks.
We have refreshed the longer-term, strategic construction of our fixed income sleeves by consolidating into a broader bond market exposure (across many sectors) and switching to a potentially higher-quality play on risky credit through “fallen angel” bonds (i.e. high yield bonds that were previously rated investment grade).
Portfolio Changes Since Last Quarter
Overall Asset Allocation
Trade Rationale
- Aggressively supportive monetary policy, low yields and resurgent economic prospects bolster our continued preference for equities over bonds. Over the course of the year, we expect vaccinations will drive steep and sustained declines in COVID-19 infections, driving a surge in consumer confidence and demand globally.
- A goldilocks political environment adds further fuel to the longer-term reflation trade. The ‘light blue wave’ election outcome may increase the prospect for larger fiscal stimulus and associated spending programs, but more polarizing agenda items could be more difficult to pass.
- But as of now, downward pressure created by COVID-19 continues to present near-term risks, as seasonal factors exacerbate infection rates, more contagious strains of the disease are discovered in society and the rollout of vaccinations hits logistical speedbumps. Further, while our outlook for equities post-election has been positive, prices could now be vulnerable to a short-term correction. Given these risks, we are tactically reducing our position in equities by 1% but remain overweight.
- We expect cyclical names most adversely affected by shutdowns and social distancing restrictions to outperform but remain committed to complementing these positions with allocations to growth and momentum, which have increasingly served as ballasts in a post-COVID-19, zero-interest rate world. Consistent with this theme, we are bringing our US v DM regional bets back to benchmark, seeing more attractive near-term rebound opportunities in European stocks, which reflect a structural midcap/value tilt.
Portfolio Performance
The opening act of the new age “roaring twenties” was a seminal moment in financial market and human history: a tumultuous period defined by a curious dichotomy of pandemic-driven apocalyptic conjecture and the return of retail-driven speculation. Despite an ominous backdrop of accelerating COVID-19 cases, more contagious strains of the disease popping up across the developed world and vaccine rollouts hitting implementation speedbumps, risk assets ended the year near or at all-time highs, with some of the most business cycle-sensitive sectors leading the latest leg of the rally. Scorned value stocks had their best quarter in over a decade, small cap stocks’ powerful year-end ascent helped reduce their previously steep YTD underperformance, and energy-sensitive names marched higher in conjunction with the steady recovery in oil prices. Emerging market stocks led from a regional perspective, buoyed by Chinese demand, a weakening US dollar and attractive relative valuations. The yield on the US 10-year Treasury creeped higher over the period to 0.90%, which may have been driven by investors’ rising inflation expectations and general risk-on mood but remained materially depressed from the 1.90% seen earlier in the year.
All models posted positive performance and outperformed their benchmarks for the quarter, benefiting from an intraquarter trade to re-risk post-election, capturing most of the risk-on rally across equities into year-end. US large cap, ESG-optimized EM, and growth-oriented DM stocks were the largest contributors to return. US small cap and value factor stocks were also meaningfully additive to performance, serving as the primary catalysts for broader portfolio outperformance over the period, consistent with our expectations of a cyclicals-led economic recovery. The only detractor to performance was US government bonds, which we were underweight relative to the benchmark and whose weakness was more than compensated for by broader overweight positions in equities and high yield credit.
Asset Class Views
| Asset Class | Views | Rationale |
| Asset Allocation | ||
| Equities vs. Fixed Income |  | We maintain an overweight to equities, but less so than last quarter, seeking to mitigate downside vulnerability to a possible short-term market correction. However, we are confident in the longer-term sustainability of a cyclicals-led economic expansion, so continue to express an overall risk-on outlook. Consistent with this theme, we are bringing our U.S. v international developed market regional bets back to benchmark, seeing more attractive near-term rebound opportunities in European stocks, which have a structural midcap/value tilt. |
| Equity | ||
| U.S. Equities |  | We eliminate our long-standing overweight to U.S. equities, primarily by reducing exposure to large cap and medical device stocks. Less attractive valuations and a desire to rotate exposure from mega cap/growth-oriented names and into small cap/value-oriented names support our reallocation thesis. |
| Non-US Developed Equities | | We increase our underweight to the International equities market, seeing limited opportunity for relative upside due to a lukewarm economic recovery and weaker revisions to earnings estimates across Europe. Further, sluggish trade activity, a resurgence in Covid-19 cases, and the return of Brexit uncertainties compound an already unattractive risk/reward profile. |
| Emerging Market Equities | | We think emerging market equities remain the most attractive from a regional perspective, led by an impressive post-Covid turnaround in Chinese economic activity. We maintain an overweight position across portfolios. |
| Smart Beta | | Given the current recovery regime, value is our preferred factor exposure, complemented by exposure to momentum for trend-reversal and diversification purposes and to minimum volatility for broader downside protection purposes. |
| Fixed Income | ||
| U.S. Treasuries |  | We maintain a broadly underweight position in treasuries, but modestly increase overall exposure. Despite a depressed interest rate environment, we believe treasuries can continue to serve as a potent source of diversification vs. equity and credit risks and protection from downside volatility. |
| U.S. Investment Grade Bonds | | We modestly trim exposure to IG credit given the near full recovery in spreads post-Covid and a less attractive risk/reward profile but continue to see upside potential due to the broader paucity of yield. |
| High Yield Credit | | We continue to be overweight speculative grade credit, seeing the most attractive opportunities in fallen angel debt (i.e., high yield bonds that were previously rated investment grade), expressing our preference for higher-quality High Yield issues with more exposure to some of the most cyclically-sensitive sectors of the economy. |
| Emerging Market Bonds (USD) | | We maintain a strategic position in fixed-income heavy portfolios, where we remain marginally positive due to the potential carry the asset class offers. |
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