HOW OUR MANAGED ACCOUNTS ARE POSITIONED
Overall, our positioning in a general well diversified portfolio reflects a continued economic expansion in the U.S., solid prospects for growth overseas, and attractive bond yields, but with some contingencies in case unforeseen economic or market shocks occur.
We believe the current economy could move in a couple of different directions from here. For example, it appears that the full implementation of this administration’s tariff policy happened in August. Historically, there have been periods of inflation in the past, and it's possible that we could see an uptick in inflation in the coming months. Consequently, we’ve positioned accounts with some inflation protection like Treasury Inflation Protected Securities, Real Estate Investment Trusts, and commodities. Also, tariffs could stifle economic growth in the U.S., so we own some long-term U.S. Treasuries and liquid alternative investments that are potentially less prone to an economic slowdown. All in all, over the past year or so, we’ve been adding positions around the margin of portfolios to potentially help increase their durability and adaptability to a wide variety of possible outcomes.
HOW WE ARE THINKING ABOUT LESS TRADITIONAL ASSET CLASSES
One move we made over the past quarter was to add some long-term U.S. Treasury bonds. We did this for a couple of reasons. First, if the U.S. economy slows unexpectedly, we could see long-term bond yields decline. That position could act as a bit of a shock absorber in case we hit economic turbulence.
This is not to say that this is our expectation. We think the U.S. economy is in pretty good shape. But there’s a heightened level of uncertainty in the economy and that can spill over into markets. This uncertainty seems primarily driven by tariffs but recently the U.S. labor market surprised many of us with unexpected weakness. Not only was the July new jobs number weaker than anticipated, but the government recently revised previous job reports down by around nine hundred thousand jobs over past twelve months.
But it’s important to remember that the weaker monthly jobs report reflects one part of the labor market -- that’s new job growth. Other measures paint a better picture. For example, the weekly claims of displaced workers filing for unemployment insurance have been low for the past couple of years. Also, the percentage of unemployed workers is hovering around 4.2%, which remains well below the long-term average of about 5.6%. Finally, we at Fidelity have proprietary information that informs us as to the health of the jobs market.
Fidelity has proprietary access to jobs data for a significant portion of the U.S. economy. That means Fidelity can see how many companies are adding to their workforce, and we compile this data every two weeks. In general, our data doesn’t always match up with the monthly government data, so we can look for what might be causing differences to understand it better.
Over the past year or so, our data was tracking below the government’s new jobs reports. That has been one of the reasons why we’ve been somewhat cautious. And with these recent revisions, the government results came more in line with ours. We view this, along with several other proprietary capabilities, as an advantage in assessing economic and market conditions.
THE FUTURE IMPACT OF TARIFFS
Our analysts think that tariffs are likely to add about 1% to inflation and reduce GDP by about 1%.1 Leaving inflation aside for now, the constraint on economic growth presents a challenge to the U.S. economy, which has already slowed somewhat. We saw year-over-year GDP growth of 3% for the second quarter but a lot of that growth was due to very low imports after an unusually high amount in the first quarter. So basically, the organic growth of the economy was much lower, closer to 1.5%. That’s still okay but far away from 3%.
Getting back to tariffs, if our analysts’ estimate is correct, growth drops to more like 0.5%.2 Again, any growth is good, but a near-zero growth rate will hinder certain industries that rely on economic growth to prosper – think automotive, construction, and commercial banks.
Going forward, what we’re hoping to see is the government follow through on its third economic promise, deregulation. So far, it’s given us tariffs, then a tax package, and their next effort will be on deregulation. Some of the areas targeted for regulatory relief include banks, which could make lending more available. Also, there have been numerous announcements about onshoring manufacturing that had previously moved overseas. Deregulating permitting in the construction sector could accelerate projects to build manufacturing facilities.
As for inflation, to the extent tariffs push it even higher, it puts the U.S. Federal Reserve Bank in a tricky spot. Persistently elevated inflation readings have kept the Fed from reducing the overnight rate. That doesn’t seem to be going away any time soon and tariffs may exacerbate the problem.
Making things trickier now is that the labor market is wobbling a bit. If that continues the Fed would likely want to cut. So, if I had to choose, I’d say the Fed would rather support a soft labor market than risk a widespread weakening. There is a possibility that they reduce the overnight rate by 0.25% or even 0.5% between now and year-end.
Once again, we’re faced with a blurry picture here. When thinking about making investment allocation decisions, a weakening jobs market suggests that we should increase defensiveness. But, on the other hand, if rates are going lower, that suggests a more growth-oriented approach. These are the kinds of issues my team of analysts and portfolio managers follow closely, and we meet often to discuss them.
GROWTH-ORIENTED VS. DEFENSIVE POSITIONING IN CURRENT ASSET ALLOCATIONS
Generally speaking, for a 60/40 managed account, we’re well-balanced between growth and defensiveness with our positioning mostly aligned with our benchmarks. We have slight tilts that we believe mitigate some of the economic challenges we discussed and other tilts that are intended to take advantage of improvements should they occur.
For example, we have a slightly lower U.S. stock allocation than our benchmark. That’s primarily for two reasons. First, as we discussed, there has been some softening in the U.S. economy which could be a drag on some industry sectors. Second, the U.S. stock market is heavily concentrated in a handful of very large, technology-oriented companies. If something goes awry with just one of those, it could drag the market lower. Also, this concentrated group of stocks have very high valuations which have brought the broader market valuation above long-term averages.
Somewhat offsetting the U.S. position is a slightly higher allocation to international stocks. In a 60/40 portfolio, that means we have about 19% allocated to both developed and emerging market international stocks. A few recent developments have influenced our decision here.
First, valuations of overseas stocks are right around their long-term averages and they do not face the same concentration risk seen in U.S. stocks. Second, there have been some structural changes in fiscal and regulatory policy in the European Union that could invigorate economic activity and support stock performance. These changes are anticipated to potentially influence the region in the coming years. Moreover, the investment in artificial intelligence isn’t just contained to the U.S. The potential beneficiaries of the massive amount of money being spent on developing A.I. spans the entire globe. Finally, China has yet to break out of a multi-year slump but if that occurs, its huge economy could provide incremental improvement to the global economy.
The bottom line is that the U.S. and international positions result in a relatively neutral overall stock position. And when combined with the diversified positions into bonds and the other less traditional asset classes we discussed earlier, we aim to position our clients' assets in a way that could potentially help them achieve their long-term financial goals.
KEY ADVICE AMID THIS UNCERTAINTY?
Remember, markets reward patience—near-term bumps often create buying opportunities for long-term investors. So if you’re waiting to make a move into the market, or you thinking about timing the market, don’t.
Stick with your financial plan and reach out to your advisor if your financial situation or risk tolerance changes.