Once a quarter we find it helpful to offer a high-level review of our portfolio strategy. Below we provide our thoughts on the two key asset classes in our client portfolios (bonds and equities) before offering a high-level summary of the risks on our radar. The bottom line: we are positioning our portfolios for superior income as we give time for our more growth-oriented investments to materialize. That said, we expect the next few quarters to be bumpy as we work through a volatile political and economic environment.

Bonds – Times have changed. Embrace it.

Investors have understandably shied away from fixed income over the last decade. It was hard to get excited about bonds when they were yielding 1%. But the world has changed. The yields on bonds and other fixed income have not been this high in over 15 years. High quality fixed income is yielding close to 5.5%, a number that surpasses the conservative return goals of many financial plans. Today’s bonds also come with a unique opportunity created by the rapid interest rate hikes of 2022: much of their yield comes through capital gains. This makes bonds a lot more tax effective than a GIC (which are taxed all as interest income) and therefore,  more attractive.  To put it in perspective, a bond today is equivalent to owning a GIC that will earn you greater than 7% (click here for our blog post on this topic). In this world, it once again makes sense to allocate a larger portion of wealth to fixed income.

This is exactly what we are doing in our portfolios. For balanced mandates, we are closer to 50-50 in the relative weight between equities and fixed income than we have been in years. We expect to move even closer to equal weight over the next six months. It finally pays to be a saver again.

Equities – Shrinking allocation not shrinking opportunity.

Equities are naturally making up a smaller portion of our portfolio as fixed income and related allocations rise. This should not be taken to mean we do not believe in the potential of stocks moving forward. In fact, given the turmoil we experienced last year, we would not be surprised if the average annual returns in this space are greater than 10% over the next 5 years. However, given the relative risk-reward of stocks vs. bonds following the increase in yields, we believe it is worth tilting towards the latter. This is particularly true for investors who are more interested in capital stability and risk management than outsized returns.

As of now, the bulk (approximately 85%) of our stock holdings consist of high-quality dividend-payers. These are mature companies with predictable earnings that hold up well throughout the course of a business cycle; think top-tier names in the staples, health care, and industrial spaces. The rest of our portfolio revolves around companies in focused on growth. This is where we see the biggest opportunity moving forward, as this is where we have exposure to themes like AI, genomics, robotics, and other areas of technological innovation we believe will be at the center of the next era of economic growth. Granted, these areas have received a lot of attention over the course of 2023. However, the more we learn about them, the more we believe the market is currently under-appreciating the extent of the impact of these emerging technologies over our economy.

The net result is that our portfolio is primarily income-focused with a tilt towards growth. In our view, this allows our clients to collect a healthy “paycheck” on their money as they allow time for their more future-focused investments to bear fruit.  

Risks – What we’re watching.

Below is a list the key areas of risk we are watching as we move into the final quarter of 2023 and the onset of 2024.

1. Headline Risk Associated with US Politics – We are not highlighting this because we think it is a source of genuine risk (we don’t). We are doing so because it is likely to take up a large portion of headlines over the coming weeks and months. During this time, the media is likely to jump all over the prospect of a government shutdown before ultimately turning their attention to next year’s presidential election. In both cases, their will be a lot of political hand-waving and potentially scary-sounding headlines. And yet our analysis of past cases tells us any impact they have on markets tend to be temporary in nature. Maintaining a cool head will be paramount moving forward.

2. Geopolitical Risk – As long as the war between Russia and Ukraine goes on, there is a risk that something could escalate in a way that impacts not just markets but our global society at large. Meanwhile, we are hopeful that the tension between the US and China over Taiwan may subside as Chairman Xi turns his attention to shoring up his internal economy. That said, we cannot rule out the possibility that this friction continues to spill out in global trade policy. Both sources of risk must continue to be monitored.  
3. Policy Error – This is the most significant source of short/medium term risk to markets, in our minds. Our concern regards the Federal Reserve and US monetary policy. Unfortunately, there is a fine of a line between containing inflation and “breaking something” when it comes to the economy. Our sense is that they are closer to the latter than they realize. The further they push up interest rates and maintain a restrictive credit environment, the greater the chance they do some outsized damage. Click here to read our post on this topic.
4. Recession – Related to the risk above is the prospect of a recession. Granted, this has been on the market’s radar for some time and we have so far been able to avoid one up to this point. But signs of over-extension are starting to show. Consumers, which make up roughly 70% of economic spending, are stretched. They’ve spent through their pandemic savings and are now beginning to feel the strains of higher interest costs. Both economic data as well as the anecdotal discussions in our network tell us credit is beginning to tighten for everyone (businesses included). Once credit tightens, the economy tends to follow. We therefore think it is prudent to continue positioning portfolios for higher volatility as the market digests what this might mean for the economy over the next 6 months or so. As we mentioned before, however, the market returns following these choppy periods tend to be some of the most lucrative. Staying patient and nimble is key.