The Argent Trust Allocation and Strategy committee met Wednesday afternoon as part of our regular meeting schedule. As usual we discussed the current state of markets, valuations, economic trends, sentiment, and other matters that may affect securities prices and investment returns. Two issues in particular seem to be creating concern for the markets right now: the speed of rising interest rates and potential for slowing global growth rates.
We have had a firm expectation that the Federal Reserve would follow through on raising short term interest rates along a path which has been signaled for many months. Presently, the Fed Funds rate yields 2.25% (up from close to 0% less than 36 months ago) and longer term rates have risen accordingly (although not as much as short term rates, which has resulted in some ‘flattening’ of the yield curve). Recent days have seen longer term rates rise more quickly than we have seen in previous months, causing some stress in the markets. However, it is important to remember that these long term rates are still much lower than historical norms. As we have for some time, the committee continues to recommend that fixed income portfolios focus on shorter durations and seek additional return through careful targeted allocation to High Yield, Emerging Market, and funds with flexible mandates.
As we have pointed out in past communications, with interest rates rising from historically low levels, longer term bonds are not priced to offer as certain a defense against declines in equity prices as in past cycles. And so in today’s interest rate environment, we are more often seeing bond prices and stock prices decline together, a phenomenon that has been uncommon during the generation long trend in falling interest rates. A portfolio must own shorter duration bonds to provide offsetting protection against falling equity prices.
In equity markets, we continue to be cautious about valuations (due to rising rates and potential developing headwinds to earnings growth caused by labor costs, trade costs, currency movements, and other inflationary factors – although to be clear, such headwinds are not yet apparent in the available economic data). We also maintain overweight positions in foreign equities and underweight positions in domestic equities relative to our neutral targets.
The recent unsettled markets action does not surprise us (what is more unusual was the long period of relative calm in the markets up until the 1st quarter of this year). As markets digest new and evolving trends in available data, it is normal to have days with price declines similar to what we experienced Wednesday. Our focus remains on ensuring that clients have the proper long term asset allocations and on evaluating markets for any signal that would cause us to review our long term recommended positioning.