FFinancial advisors can turn to ETF allocation strategies to enhance their exposure to fixed income and equities and to better tailor their clients’ investment portfolios to current market conditions.
During the recent webcast, Macro Polo: Finding the Right Investment Strategy for the Moment, Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors, described the current state of the market environment. With the S&P 500 entering a bear market, investors remained cautious of further tightening from the Federal Reserve as whispers of a recession loom. Meanwhile, equity allocations fell to their lowest level since late 2020, with cash allocations hitting their highest level in nearly a year. Consequently, wild swings in the markets limit the equity-bond differential range.
Looking ahead, Bartolini warned that bearish signals are mounting, with investors seeing continued volatility for the next six months. Sentiment readings are still below 100, indicating a slight defensive bias towards risky assets.
Bartolini also noted that growth forecasts continue to be revised lower in emerging markets while US large caps have seen growth revised higher. Nevertheless, earnings sentiment continues to weaken globally.
In fixed income markets, the entire yield curve rose in June, but flattened, with the short end rising more than the long end. The yield curve briefly inverted in June for the second time since 2019 on the heels of stronger-than-expected inflation and fresh growth dampening Fed action, Bartolini added. While credit spreads widened slightly in June, levels are still below their long-term average. Additionally, base yields have risen, but most asset classes are slightly above expected inflation levels and offer little real income.
Thomas Urano, managing partner, portfolio management at Sage Advisory, warned that financial conditions were tightening at the same rate as previous recessions, with economic activity slowing globally. Commodities also reflect a global slowdown as prices may have already peaked.
Looking ahead, options traders are betting that the Fed may slow monetary policy tightening. Urano noted that market expectations for federal funds terminal rates are falling. Forward pricing of the Secured Overnight Funding Rate (SOFR) tells us how the market values future FF rates. Apart from the anticipation of a drop in the terminal rate, the market does not expect a rate hike in 2023.
Urano even argued that the current tightening cycle is priced in more aggressively than usual. Aggressive Fed tightening expectations were priced into rates early, or earlier than in previous cycles. This resulted in returns far from the usual pattern during rate cycles. Higher yields across the curve will mitigate the negative impact of widening spreads from current levels. Given the flatness of the curve, there would be a moderate impact on the front end of the curve.
Consequently, Urano believed that concerns about growth and balance sheet tightening could continue to pressure spreads in the near term. However, valuations better offset these risks and suggest upside opportunities over the next 12-18 months.
Bryan Novak, senior managing director at Astor Investment Management, said that while rates are discounting multiples, growth estimates for next year have also fallen rapidly. Therefore, a catalyst for markets to move forward will require certainty on terminal rates, a spike in inflation and an improving outlook for growth.
On the inflation front, Novak argued that demand- and supply-based contributions to inflation have both been strong, and recent data suggests the worst may be behind us.
Investors can begin to reassess their fixed income portfolios with the addition of ETF strategies to better manage market exposures. Novak pointed to fixed income ETFs, which could enable flexible and tactical portfolio solutions, managing credit and interest rate risk.
Financial advisors interested in learning more about investment strategies for today’s market can watch the webcast here on demand.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.