In the recently released Q1 2021 Investment Insight newsletter, we commented that no changes were being made to the asset allocations being utilized across client portfolios. Since preparing the content for the newsletter, the Asset Allocation Committee has determined it is appropriate and timely to execute a shift in allocation. This shift involves reducing U.S. equities to a neutral weight and migrating the proceeds from the reduction to fixed income.
The primary driver behind moving our equity weighting positioning to neutral was a desire to lower the risk profile within our allocations. Given the strong performance of equities, particularly U.S. equities, since the low established in March 2020, and accompanying increase in valuation levels over that time period, we felt it prudent to return to a neutral positioning. Specifically, equity market valuations are currently historically high. At the end of the first quarter, the forward price-to-earnings ratio for the S&P 500 Index was at 21.9x compared to the 25-year average of 16.6. This reading is 1.6 standard deviations over the historical average.
Also, some of the catalysts that have propelled equity markets to new highs may not be as powerful in the future. An end to COVID-related stimulus payments, the prospect of higher marginal tax rates and a shift in regulatory policy all provide potential resistance to higher moves in equity prices.
To reiterate, we are not moving to an underweight in equities at this time, merely back to a neutral positioning.
In regard to moving the proceeds of our domestic equity reduction into fixed income, below are some supporting observations.
Recent experience of equity drawdowns (stock market declines) approaching 20% have been met with positive returns on the Bloomberg Barclays Aggregate Bond Index. These include the latest recession, the Federal Reserve hiking cycle in 2018, the growth scare of 2015-2016, and the European Union’s sovereign event in 2011-2012.
Given the level of stock market capitalization relative to GDP, drawdowns in equity indices could cause a greater impact on future consumer spending versus previous decades. Therefore, equity drawdowns could alter the economic growth trajectory in a manner that lowers growth and inflation, causing yields to fall and fixed income to post positive returns.
In these scenarios, it is the long end of the Treasury market that would provide the upside and serve as a hedge to equities. Investing in short-duration Treasuries would provide little offset should equities enter a drawdown.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet, Refinitiv.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
The information within this document is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and you should not interpret the statement in this report as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.