Buttonwood Investment Policy Committee Update – August 2021

Overall the markets continue to trend higher on the back of substantial stimulus and low interest rates. As the summer heat sets in, an anxious tone seems to be in the air as traders look forward to see if they can find the peak for the latest Delta spike.

As mask mandates return, so too is a resurgence in vaccination rates – the combination of the two seems to have a focus on late September as the turning point. If the Delta variant doesn’t show signs of a peak, increased concerns of lockdowns rise, and the markets retreat. Ahhh, welcome to summer volatility.

We have certainly had quite a period of extraordinary returns and would not be surprised to see a correction in the markets. That said, we continue to maintain a broadly bullish stance in-line with our base case reflation scenario for our allocations. We continue to temper active risk as the market toils with persistent policy and Covid risk headlines.

To do this we remain overweight equities on a strategic basis, as we see valuations as reasonable after accounting for the expected path of interest rates – lower for longer.  At the same time, we are recalibrating our cyclical/defensive barbell to add to duration-sensitive hedges, seeking to capture more symmetric exposure to interest rate volatility.

The status of fiscal and monetary policy remains front and center in the minds of market participants, as inflation expectations continue to creep higher and investors question how policy makers may respond. Market moves following the June FOMC meeting showed that investors were laser-focused on the Fed’s so-called dot plot movement (see graph on page 4) , which the U.S. central bank uses to signal its outlook for the path of interest rates. The graph indicates the likelihood of two hikes in 2023 and a potential shift to more hawkish positioning going forward. However, the Fed has been careful to soften their messaging in subsequent communications.

The Fed maintains the view that the pick-up in inflation is transitory and thus is expected to ease.  While we are not so sure about this point, we do believe the Fed will remain patient in their approach to raising interest rates and tapering asset purchases.

The fiscal policy “party” also rages on, with a $1.2T bipartisan infrastructure bill and a $3.5T unilaterally Dem supported budget resolution bill both coming to the floor soon.

Considering this base case, during our recent August rebalance, we once again reduced exposure to historically expensive credit. With these assets we added to Treasury Inflation-Protected Securities (TIPS) at a relative discount. We did this to take advantage of the recent pullback and further insulate our fixed income from inflationary pressures.

In stock allocations, we continued to add to Developed Market (DM) equities, a relatively undervalued regional exposure with room to run in the economic recovery trade. Europe, which has lagged in the recovery due to political missteps and vaccine distribution hurdles, has improved, which is key to our increasing bullishness in the region.

We believe most of the cited catalysts for a sustained trend reversal and cyclical slowdown lack a convincing narrative. Perhaps contrarily, we take the Fed at its word to remain patient with respect to the pace of tapering and future interest rate hikes. We don’t see the Delta variant as a likely candidate to disrupt the economic restart, primarily due to the successful rollout of vaccination programs across DM economies (Emerging Market economies is a different story). Lastly, we believe the ‘transitory inflation’ trade is likely mostly priced in, leaving little upside and considerable vulnerability to shifts in sentiment.

We will continue to provide ongoing updates on our views and investment positioning. Should you have specific questions about our strategy, please let us know and we will make sure to review details at our next meeting. And while we don’t recommend fixating on short term market fluctuations, if you would like to check specific investment performance across all your accounts, our Buttonwood Portal is available 24/7. Or you can contact us, and we will provide reports specific to your questions and financial life.

Thank you for your continued trust and allowing us to serve as your Family CFO!