In last month’s commentary we expressed concern about the lagging price action of high-yield bonds relative to equities, especially the leading Nasdaq stocks. Our fear was that continued economic weakness would eventually cause the equity market to roll over, dragging high-yield bond prices down with it.
Adding to our concern was that equity strength was attributable to a narrow cadre of Nasdaq leaders, mostly tech names, while the broader list of stocks languished. That’s usually a sign of an impending correction. However, to our surprise, high-yield prices began to strengthen and, rather than weaken, equity indices reasserted themselves to the upside driven by a broadening number of advancing stocks. Our indicators responded to the healthier profile of the market by signaling it was safe to reposition high-yield portfolios and move to a fully invested “risk-on” posture.
Our more bullish posture relies, at least in part, on the determination of the Federal Reserve and Congress to prevent a general economic collapse by a willingness to provide whatever monetary and fiscal stimulus is deemed necessary to achieve that goal. Despite this, we believe prudence is warranted. Investors are still faced with unprecedented and formidable challenges on many fronts. No one can predict the course of the coronavirus, the catalyst for the market’s history making plunge earlier this year. The extreme social measures mandated to contain the spread of the virus – which also threaten to collapse the economy - are still in place in many parts of the country.
The world has become much more unpredictable and subject to unexpected shocks. The current civil unrest sparked by an incidence of police brutality is a perfect example. Developments like this can negatively impact consumer sentiment and risk appetites.
The overall elevated risk level is heavily influencing our portfolio composition. The emphasis is on holdings that typically exhibit lower than average volatility and moderate drawdowns in a negative market environment, while still offering attractive upside potential if market conditions remain favorable. In sum, we believe that our positions have the potential to enable us to be flexible in the event of an upward trend in the market, or protect us should conditions deteriorate.
Bruce P. DeLaurentis