Investment Policy Committee Update - August 2023

As we move into the 2nd half of 2023, equities have been resilient in the face of a number of events since March. Events that would have whipsawed markets and maybe even started a recession in the past, were instead treated as only mildly irritating bumps in the road. Silicon Valley Bank collapse and overall banking crisis? ‘No Problem!’ Approaching the deadline on a government default? *Yawn* Another series of Fed hikes with short-term rates potentially reaching 6%? ‘Bring it on!’ A pleasantly surprising run, heroically led by a narrow set of stocks: the ‘Magnificent 7’ tech giants. Following this dramatic outperformance by those with outsized exposure to the A.I. boom, we’re reducing our tech overweight. We expect risk assets to take a breather in Q3 and the drivers of return to broaden to YTD laggards, like midcaps. 

Does all this mean we’re out of the woods? Not necessarily. In our view, while the worst ‘unknown unknowns’ emanating from the bank failures now appear to be off the table and cuts in lending appear less than severe, stocks have been partially propped up by one-time infusions of liquidity – from the Fed’s emergency bank lending program and the US Treasury’s General Account (TGA) balance drawdown – which are now reversing. Between March and June, these infusions more than offset the Fed’s on-going quantitative tightening (QT). But that’s behind us now and commercial bank reserves at the Fed are falling again. We think this is likely to cause some market indigestion later in Q3. This explains our cuts to liquidity-sensitive assets like emerging market stocks and lower quality credit. 

Nonetheless, we do believe the odds of recession are lower than 4 months ago. This reflects the lingering power of ‘revenge spending’ by consumers, fueled by post-pandemic pent-up demand and excess savings. But the economy’s impressive resilience may also make the endgame battle against inflation trickier than the 9%-3% freefall in CPI the last 12 months. The Fed appears committed to flexing its rate-hiking and QT muscles into the final rounds of this fight, and Treasury markets have re-priced accordingly (perhaps even overshooting). We’re taking advantage of this surge to add yield via floating rate Treasuries and TIPS, which we see as having higher than normal real yields, complemented with long-term Treasuries. This barbell strategy may help guard against the cumulative effects of Fed tightening potentially proving to be excessive vs an already weakened foe, bringing to fruition what so many have been calling for the last 18 months: the R word. 

In summary:  

In aggregate, we move to a neutral stock/bond position while reducing overall active risk. In our last trade in March, we shifted underweight stocks vs. our benchmark based upon concerns that regional bank stress would cause broader contagion and liquidity issues across the US economy. Following swift policy response, we saw markets largely shrug off this risk and the concerns of such a snowball effect have been eliminated in our view. 

Within equities we are taking profits on year-to-date winners as we expect some broadening out of stock performance away from the top Tech names. We are trimming U.S. tech and rotating into companies we believe will be the beneficiaries of fuller market breadth, like U.S. midcap stocks. We are shifting our regional positioning in favor of the US while reducing emerging market exposure. Our caution on EM companies stems from a backdrop of scarce global liquidity and weak global trade. 

On the fixed income side, we are recalibrating the bond sleeve by introducing a treasury barbell – adding a floating position on the front end of the curve to benefit from heightened yield levels, complemented by long end exposure as a ballast to equity risk. Along with this we are reducing credit risk, preferring to move up in quality across our bond exposures. 

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 coordinate your asset management as part of our Family CFO services!