Weekly Wisdom – March 2, 2023

By Hightower Great Lakes on March 2, 2023

A Diversified Portfolio and Brief History of Market Opportunities

If you google the acronym TINA, which stands for “there is no alternative,” you’ll come across references to the late British Prime Minister Margaret Thatcher. No, that wasn’t what I expected to stumble upon either. According to Wikipedia, Prime Minister Thatcher used this slogan to support building a more robust market economy in Great Britain during the 1980s.

The reference that we would like to emphasize, and the one which is found on Investopedia, relates to capital flowing into equities because there is no alternative asset class which can substitute.

Public equity markets have generated long-term capital appreciation for investors since its advent. For much of modern history, leading up to the 2008 Great Financial Crisis (GFC), public investments could be diversified into credit markets and generate safe, real income via securities such as corporate bonds or government-backed treasuries. A popular, “moderate” diversification strategy became known as the “60/40” portfolio – representing 60% equity and 40% fixed income.

Post-GFC, we entered into a long period of low interest rate policy otherwise known as monetary policy accommodation, i.e., lower interest rates and active bond purchases. This resulted in lower cost of lending and more affordable financial conditions.

This trend was amplified upon the recent COVID-19 pandemic, when the Fed enacted extremely easy monetary policy, supported by enhanced fiscal stimulus, to support the economy amid a chaotic period.

In fact, at the peak of Covid, monetary and fiscal policies grew to 60% of GDP – an enormous amount of liquidity. Even during the GFC in 2008, monetary and fiscal policies put in place equated to just 5% of GDP. 

Fast-forward to today, and the Fed has pivoted 180-degrees – now implementing restrictive monetary policy by raising its target rate and reducing its balance sheet. In a little over a year’s time, the fed funds rate has gone from 0% to 4.75%.

The impact has yet to be felt in the overall economy other than in housing, as there is typically a 12-month lag between rate policy change and the economic impact. The good news is that there is $4 trillion in higher liquidity versus pre-Covid so there is an offset, for now.

Chart 1: 5-Year Treasury Remained Below 3% After ‘08, Recently Highest Since ‘07¹

How does this tie back to TINA? Pre-GFC, investors could diversify their portfolio and generate steady income and capital appreciation by investing in both fixed income and equity securities across portfolios. Investors could still execute this strategy post-GFC, but there was diminishing opportunity for yield in credit markets due to the low interest rate environment.

In 2021, we heard TINA repeated regularly by market pundits, as stock prices rallied because investors had excess savings and no alternative public investments that appeared worthwhile, due to the near-zero interest rates in fixed income.

In 2022, as the Fed implemented its tightening policy, fixed income and equities moved lower, in lockstep, cancelling out much of the diversification benefits (at least in the short-term).

Chart 2: In 2021, We Heard “TINA”²

Chart 3: In 2022, We Heard “the 60/40 is Dead”³

Today, we are saying that there is an alternative to equities, the 60/40 diversification approach is very much alive, and investors can take action by allocating to fixed income and using that asset class to diversify their portfolios in a meaningful way.

Current Bond Market Pricing

The Bloomberg U.S. Aggregate index – a broad-based, investment grade U.S. bond index – currently yields 4.8%. Its 10-year average yield is 2.45%. The ICE BofA U.S. High Yield index currently yields 8.6%, compared to its 10-year average 6.6%.

The option-adjusted spread for both indices is at or below the respective 10-year averages, indicating a healthy credit environment. On the inverted curve, U.S. Treasury yields range from 3.9% on the 10-year, up to 5.1% on the 6-month bill.

Investors have the option to lock-in interest rates for the longer period or park money in shorter-term securities and reinvest as they mature.

Whichever way investors choose to position their exposures on the curve or across asset types, some of the best opportunities are seen broadly across credit markets post-GFC. We advocate for a barbell approach, gaining exposure to both the short-end and locking in elevated rates near the 10-year.

Markets and the Fed

We continue to watch the Fed, which has remained steadfast in its commitment to a higher for longer interest rate policy. Bond markets initially disagreed with this narrative, predicting that the Fed would cut rates or stop hiking sooner than what the Fed was telling us.

The inverted yield curve displays these different viewpoints but even within the curve there are other smaller subtleties playing out. For instance, the 10-year yield has risen over 50 bps in the past month alone as markets have come to grip with the fact that the Fed is more serious about higher for longer than previously anticipated.

At the end of the day, the market wants and does expect lower rates, however it will just have to wait for now. While the Fed continues to underscore its Hawkish policy, and markets wait for signs of a pivot, investors will get paid to wait, collecting the highest yields on the front end of the curve while looking for signs that lower rates lay ahead somewhere down the road.

Expectations currently point towards three more Fed hikes, 25 bps in March, May and June. Labor market and inflation data will be instrumental on whether those hikes come to fruition at the upcoming Fed meetings, but that’s what the market is expecting for now. The road to lower inflation will not be smooth.

How the market and the Fed digest each data point will likely create additional opportunities along the way and is something our team watches closely in conjunction with any investment decision.

Click here to read last week’s Weekly Wisdom (2/23).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors.

All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Solutions and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Solutions and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

---

¹ Source: FactSet (chart). As of February 28, 2023.

² Source: FactSet (chart). As of February 28, 2023.

³ Source: FactSet (chart): As of February 28, 2023.