Resist the temptation to react

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Key takeaways

  • Strategic Advisers believes the U.S. economy is currently showing signs of a slowing expansion and has continued to reduce risk within well-diversified client accounts.
  • Our well-diversified total return accounts are well-positioned to withstand additional bouts of market volatility while experiencing growth should stocks continue to move higher.
  • Staying invested through periods of market volatility can help provide a better opportunity to participate in potential stock and bond recoveries.

After considerable volatility to start the year, many client accounts have experienced modestly positive results since their lows in mid-June. Yet stocks and bonds have also experienced renewed volatility over the last few weeks.

Stocks have likely moved higher since June due to second quarter corporate profits, which have come in stronger than many investors were expecting. This has been driven at least in part by healthy consumer spending, despite higher prices from inflation. Some easing supply chain issues may have also helped.

Yet the Fed’s comments in August suggested that they still see inflation as a concern for the economy. This has led stock and bond investors to debate how much further the Fed may raise rates to combat inflation. As a result, stocks and bonds have experienced some volatility over the last few weeks.

Markets may be experiencing late-cycle volatility

Our view is that the US economy is in a late-cycle expansion. That’s because while many indicators of economic growth remain positive, we are seeing signs of slowing in areas like corporate profits or manufacturing activity. Other areas that remain strong, such as the job market, are showing signs of peaking. Historically, late-cycle expansions have often led to positive returns for investors, but also instances of market volatility, as we’ve seen over the last few months.

Client account positioning

Our research and disciplined investment approach has led us reduce risk within well-diversified accounts as the business cycle has matured:

  • We have reduced exposure to US and non-US stocks, as a maturing business cycle has historically led to more bouts of market volatility.
  • Within stocks, we have more exposure to value stocks than growth, as value stocks typically outpace growth stocks when inflation is high and interest rates are rising.
  • Within bonds, we have taken advantage of higher interest rates to add to high quality bonds, as higher yields may lead to stronger returns from bonds over time.
  • Bonds can also generally provide some protection from stock market volatility, especially when their yields are higher.
  • Also within bonds, we continue to have investments in high-yield bonds, floating-rate bonds, and global bonds, as these kinds of bonds have historically performed well in the face of rising US interest rates.
  • Additionally, to help provide further protection from inflation, we have held positions in commodities, Real Estate Investment Trusts (REITs), and US Treasury Inflation Protected Securities (TIPS) since 2020, as these investments have historically held up well during periods of higher inflation.
  • More recently, we have sought to reduce some of the exposure to REITs and commodities, as we sought to manage risk within client accounts.
  • We have added exposure to alternatives in some accounts, as we believe these types of investments can provide returns that are less correlated to traditional stocks and bonds.
  • We have rebalanced accounts as we seek to keep them closely aligned with client goals and preferences.
  • Finally, we have managed for tax efficiency in portfolios where taxes matter, particularly through tax-loss harvesting during periods of stock market volatility.
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For defensive portfolios, the strategy continues to temper volatility during market drawdowns. As always, these portfolios remain defensively positioned, and we have also made the following adjustments over the last few quarters:

  • Slightly reduced exposure to developed international stocks in anticipation of rising volatility in those markets as the business cycle matures.
  • Within stocks, shifted a portion of low-volatility stocks into high-quality, dividend-paying stocks, which we believe increases defensiveness.
  • Added to high-quality bonds to take advantage of higher current income resulting from rising interest rates.
  • To help provide protection from inflation, we have maintained a significant allocation to US Treasury Inflation-Protected Securities (TIPS), as these investments have tended to hold up well during periods of rising inflation.
  • Additionally, we increased exposure to alternative investment strategies to help reduce volatility, as these have historically generated different return patterns than traditional stocks and bonds.
  • Finally, we have rebalanced portfolios to help ensure risk and return potential remains aligned with client goals and preferences and managed for tax efficiency in portfolios where taxes matter.

Diligently adjusting and rebalancing client accounts as the US economy evolves

Rest assured that we remain disciplined as we manage client accounts day-to-day. We rely on deep rigorous research and decades of investment experience as we adjust and rebalance the mix of investments within well-diversified portfolios. As the U.S. economy moves through the business cycle, we will seek to manage risk during periods of economic stress, while continuously seeking out opportunities for long-term growth. Helping our clients reach their financial goals is our number one priority.

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