Other Financial Indicators
The financial indicators listed above are just some of the metrics we use to measure financial market stress. Other, more traditional metrics, such as U.S. high yield corporate credit spreads and the health of the short-term funding markets, also suggest the recent banking challenges are contained. Certainly, this is a highly fluid situation, and we know confidence in the banking system is key in preventing these isolated events from turning into something more systemic, but from our seats, we do not think a banking crisis is imminent.
Asst Allocation Views
It’s easy to forget about long-term investment objectives when markets are fluctuating widely, but it is those moments when sticking to a well thought out plan is most critical. It’s also a reminder why a diversified asset allocation plan is important.
In response to ongoing market volatility, we would consider adding preferred securities exposure to fixed income allocations. At this point, we are taking a wait and see approach on the banks while closely watching the latest developments. The technology sector looks better to us here, while precious metals warrant consideration on the long side.
Our updated thoughts on asset allocation are outlined below.
Equities vs. Fixed Income. LPL Research’s Strategic and Tactical Asset Allocation Committee (STAAC) remains slightly overweight equities after the Committee reduced its suggested equity exposure and moved higher in quality in fixed income about three weeks ago. While we believe investors should react to recent developments in the banking sector with some caution due to ongoing risk of deposit flight, the backstops provided by central banks and bank regulators over the past week have given us confidence the crisis will be contained. But sentiment remains fragile and technical indicators we follow suggest some caution is prudent.
Value vs. Growth. The recent dip in interest rates and our technical analysis work suggest it makes sense to shift some toward growth and get closer to neutral despite above-average valuation discounts on the value side. The Committee now recommends benchmark technology sector exposure.
Small Caps vs. Large Caps. The near-term outlook for small cap stocks is challenged given larger financial sector weights, but the asset class offers compelling valuations, in our view, to support attractive returns over the next 9 to 12 months—our targeted tactical asset allocation time horizon.
Developed International vs. Emerging Markets. European bank stress and a potential flight-to-safety rally in the U.S. dollar create near-term headwinds for developed international equities. The STAAC remains comfortable with its neutral stance, its underweight position in emerging markets equities, and slight overweight for U.S.
Financials Sector. The ongoing fragility of the banking system, coupled with the negative impact on bank profits from these recent events, leaves us neutral on financials for now with a strong preference for high quality. Fundamentals and valuations suggest the insurance industry looks ripe for opportunities.
Commodities. We consider precious metals an attractive opportunity, particularly gold, in this macro environment. Rising recession risks have weighed more heavily on industrial metals and energy, offsetting catalysts from China’s ongoing economic reopening. The technical setup for West Texas Intermediate (WTI) has deteriorated, and we are waiting for more evidence of price stability before making a bullish call on oil.
Fixed Income Positioning. On the fixed income side, the Committee continues to believe a mostly up-in-quality approach makes sense. Core bond sectors (U.S. Treasuries, Agency mortgage-backed securities [MBS], investment grade corporates) offer income potential and provide diversification to equity market stresses. Preferred securities are the only “plus” sector we believe is worth a small allocation due to valuation discounts offered by the ongoing bank health concerns. The STAAC continues to view high-quality core bonds as good diversifiers offering attractive yields in the current environment.
Bottom line, we believe tactical investors should be maintaining their multi-asset allocations at or near benchmark levels with an emphasis on diversification. We continue to monitor bank industry and macro conditions and will communicate any changes to our tactical views as they occur.
George Smith, CFA, Portfolio Strategist, LPL Financial
Jeffrey Buchbinder, CFA, Chief Equity Strategist, LPL Financial
Lawrence Gillum, CFA, Fixed Income Strategist, LPL Financial