Our conversations with investors point to growing anxiety over the economic and market path ahead. The COVID-19 Delta variant is slowing the recovery, companies face disruptions and supply chain bottlenecks, the Fed is preparing to taper its asset purchase program, and tax increases loom. With asset prices boasting record levels, how will the markets hold up?
Our view is that strong economic and corporate fundamentals mean the recovery can be sustained and risk assets will continue to move higher. However, we are shifting into the mid-cycle phase of economic recovery. As a result, we expect positive but moderating equity gains, more frequent pullbacks than in the last year, and ongoing leadership rotation across asset classes and sectors.
This base case presents an altogether constructive backdrop for investing. The best days of cyclical value may be behind us, but it’s too early to fully turn to defensive themes. We believe it’s better to stick with the reflation trade, but with a focus on identifying companies likely to experience upward earnings revisions. We favor a global allocation, with an overweight to international developed equity. Value and small-cap equities, with a focus on quality companies, should continue to thrive.
As the economy strengthens and Fed policy adapts, rates are likely to rise. Investors may be complacent to this risk. Rather than moving into cash, we are utilizing short duration securities in our portfolios and prefer credit over duration risk. Keep in mind that higher rates do not mean high rates. Investors may still need diversified sources of income in a balanced portfolio. A focus on multi-sector and multi-asset income can help build portfolio resiliency, while still leveraging these base-case themes.
While our view on the economy and markets is cautiously constructive, we acknowledge that investors face many risks and uncertainties ahead. For those investors concerned about less optimistic market outcomes, our latest market insights piece provides alternative scenarios and their investment implications.
Our strongest conviction is that, even amid market risks, investors should stay focused on their long-term investment goals. While there are pockets of investor complacency and excessive valuations, the worst action an investor can take is to greatly reduce risk – cash and duration may do little to bolster a portfolio in this phase of the cycle.
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