The second half of 2019 is upon us, and investors have plenty to worry about.
From reading cues from the Federal Reserve, to making sense of ongoing trade wars, to assessing geopolitical risk, questions abound about what U.S. and global growth look like going forward.
Year to date, ETF investors have piled into fixed income strategies, showing some aversion to risk—a theme that has prevailed this year, and by most accounts, one that will continue to guide investment decisions.
Year-To-Date Asset Flows As Of Mid-June
|Net Flows ($, mm)||AUM ($, mm)||% of AUM|
|U.S. Fixed Income||57,699.73||671,852.31||8.59%|
|International Fixed Income||6,602.36||75,151.04||8.79%|
Looking ahead, how should you allocate your portfolio in light of so much uncertainty?
We asked ETF strategists what’s top of mind for the coming months, and how best to invest in the second half of the year. Here’s what they had to say.
Gary Stringer, president & chief investment officer; Memphis, Tennessee-based Stringer Asset Management
We have recently been paring back our equity market exposures. While the U.S. stock market is nearing all-time highs, some of our favored economic indicators have weakened. Their weakening suggests sluggish economic growth ahead, and their deterioration will likely make equity markets more vulnerable.
As a result, we have recently moved to further increase the defensive nature of our strategies. We think the Fed will begin to reduce short-term interest rates soon in response to the weaker economic growth.
However, we’re concerned the Fed won’t act soon enough or forcefully enough to avert further economic deterioration. Though we have positioned our strategies somewhat more cautiously, we continue to expect global economic growth and higher equity prices, subject to bouts of volatility.
Here are our favored choices currently:
- U.S. Equity: health care (iShares U.S. Medical Devices ETF (IHI)); low volatility (iShares Edge MSCI Min Vol U.S.A. ETF (USMV) and Invesco S&P 500 ex-Rate Sensitive Low Volatility ETF (XRLV))
- Global Equity: low volatility (iShares Edge MSCI Min Vol Global ETF (ACWV)); infrastructure (FlexShares STOXX Global Broad Infrastructure Index Fund (NFRA)), value style and Asian emerging markets (SPDR MSCI Emerging Markets StrategicFactors ETF (QEMM) and iShares MSCI Emerging Markets Asia ETF (EEMA))
- Fixed income: short and intermediate-duration high quality bonds (First Trust Low Duration Opportunities ETF (LMBS), SPDR Bloomberg Barclays Mortgage Backed Bond ETF (MBG), SPDR Portfolio Aggregate Bond ETF (SPAB), SPDR Portfolio Intermediate Term Corporate Bond ETF (SPIB); and taxable municipal bonds Invesco Taxable Municipal Bond ETF (BAB))
- Alternatives: diversified alternative income (Multi-Asset Diversified Income Index Fund (MDIV), iShares Morningstar Multi-Asset Income ETF (IYLD); merger/arbitrage IQ Merger Arbitrage ETF (MNA); and covered call writing Invesco S&P 500 BuyWrite ETF (PBP))
John Davi, CEO & CIO; New York City-based Astoria Portfolio Advisors
There’s no shortage of bad economic data. Morgan Stanley’s Business Conditions Index recently had its largest one-month decline since 2002, and is near its 2008 Great Financial Crisis level. We’ve seen weakness across manufacturing surveys, capital spending, durable goods orders, payroll data, inventories, commodity prices and oil demand. The earnings picture globally is also poor.
At one point in December 2018, the S&P 500 had fallen as much as 20%, and earnings troughed at around 14x. At Astoria, we felt as though the risk/reward to buy equities back then was attractive. Unfortunately, after a 25% rally off the December lows, U.S. stocks aren’t providing an overly attractive risk/reward. Investors should now proceed with caution.
In fact, when we look across all public and private markets, most asset classes are fully valued. Private equity firms, which historically were able to buy assets at 7-8x cash flows, are now buying businesses at 12-13x. Real estate has skyrocketed across the country, and ROIs have been driven to very low levels.
What’s cheap? U.S. value, U.S. cyclicals, all international markets, commodities and digital assets. However, most investors wouldn’t touch these assets with a 10-foot pole.
Our dynamic portfolios largely have factored a weakening macro environment, as we’ve been reducing equities, increasing cash, using more bonds, and raising our alternatives exposure for the past two months. Our portfolios have the following tilts:
- For stocks, we remain focused on high quality U.S. companies along with emerging market equities that have strong balance sheets with the ability to grow earnings and dividends.
- For bonds, we prefer the highest quality securities such as mortgage-backed securities, U.S. Treasuries and municipal bonds.
We’re using more alternatives in our portfolios with ETFs that provide negative correlations to stocks—gold, gold equities, merger arbitrage and long/short market neutral strategies.
Remember, markets are forward-looking, and the rate of change is what ultimately drives financial assets on the margin. Now is not the time to take excessive risk. If you’re sitting on gains, take some profits and be patient.
Ben Lavine, CIO; East Hartford, Connecticut-based 3D Asset Management
Now that the June Fed meeting is behind us, it appears the consensus scenario is for at least two rate cuts this year (if not three), and a 1.25% Fed Funds by July of next year.
The Fed has removed itself from the picture, opening the way for a weaker U.S. dollar, which should help global trade flows and liquidity. If the expected rate cuts are early enough, they may preempt an economic contraction, breathing new life into this 10-plus-year bull market.
Focus will now shift toward ongoing trade discussions between the U.S. and its major trading partners.
Aside from a breakdown in trade relations resulting in new tariffs, we see some near-term issues that have the potential to lead to greater systemic risks within the global financial system.
China’s economy is clearly feeling the effects of lower trade activity, and is on the verge of seeing its trade balance go into deficit. Stresses are appearing in their banking system, sparking fears the government won’t come to the rescue should nonperforming loans become too high of a burden. If interbank lending freezes (indicated by spikes in short-term lending rates), this could have a chain reaction throughout China’s credit markets.
We also see growing credit risks within the leveraged loan market, whose issuance is now dominated by private equity transactions. Although default rates are projected to remain low, a high-profile blow-up within leverage loans could result in a chain reaction sell-off.
Given where we are in the cycle, we believe risk-seeking investors are better compensated with equities than fixed income credit, especially below-investment-grade credit. A weaker U.S. dollar should benefit non-U.S. assets, particularly emerging markets.
Commodities should also see a bid, especially if a “low-hanging fruit” deal is hashed out between China and the U.S., leaving thornier issues such as technology transfers and intellectual property protection to be dealt with down the road.
And with Fed cuts mostly priced in by the bond market, we believe bond market proxies like utilities and real estate—which have been bid up recently—could lag pro-cyclical sectors.
Investors with sizable exposure to low volatility strategies (long-only proxies include the Invesco S&P 500 Low Volatility ETF (SPLV) and USMV) may want to consider rotating into “high quality” through long-only proxies such as the iShares Edge MSCI U.S.A. Quality Factor ETF (QUAL) and the JPMorgan U.S. Quality Factor ETF (JQUA), as well as into momentum (long-only proxy such as the iShares Edge MSCI U.S.A. Momentum Factor ETF (MTUM).)
Contact Cinthia Murphy at [email protected]
3D Asset Management Disclosure: As of the time of this writing, 3D held positions in SPLV, USMV, JQUA and MTUM.The above is the opinion of Benjamin Lavine and should not be relied upon as investment advice or a forecast of the future. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. Past performance is no guarantee of future results, and the reader is reminded that all investments contain risk. The opinions offered above are as of June 19, 2019, and are subject to change as influencing factors change. More detail regarding 3D Asset Management, its products, services, personnel, fees and investment methodologies are available in the firm’s Form ADV Part 2, which is available upon request by calling (860) 291-1998, option 2, or emailing [email protected] or visiting 3D’s website at www.3dadvisor.com.