Defense still rules in this market Defense still rules in this market\images\insights\article\shield-on-fence-small.jpg June 10 2022 June 10 2022

Defense still rules in this market

Fed should give investors no reason to stray from short-duration, value strategies.

Published June 10 2022
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The Fed “put” has been around so long, it’s hard to let go. That was evident in late May, when stocks rallied strongly off their lows for the year on reports a non-voting Fed member thought a September pause may be warranted. We were skeptical of the rally, as we feared that, once again, market participants had become complacent to the risks posed by inflation and a hawkish Fed. Events—and comments from voting members—since have reinforced our skepticism. With “peak” inflation proving elusive—this morning’s CPI report for May came in at a fresh 40-year high, blowing past consensus expectations—half-point rate hikes are all but baked in at Federal Open Market Committee meetings next week and in late July. Fed futures are pricing in 200 more basis points of hikes through the year, making a third half-point increase possible as soon as September and lifting the fed funds target range to 3.00% by year-end. To badly paraphrase Prince, this is what it looks like when Fed doves cry.

Against this backdrop, investors should continue to play defense, with a hard tilt toward shorter duration and higher quality assets on the fixed income and equity side. In fixed income, this means keeping a preference for cash and short-term credit instruments, and an underweight to longer-duration government and credit bonds. Within equities, stay underweight growth and overweight value, with a particular preference for defensive, dividend-paying stocks. Use rallies to further reduce exposure to longer-duration assets, and meaningful pullbacks to add to more defensive assets. While the run-up in energy and other commodities has created upside in some emerging markets, it’s stirred headwinds in others. So, caution is merited. Overall, our recommended multi-asset positioning continues to underweight bonds relative to stocks, with the understanding a hard landing could create potential opportunities in high-quality, longer-duration assets at some point in the future. For now, though, it’s way too soon to make that call.

If the Fed were to surprise—and there’s virtually nothing to suggest it will, particularly after May’s CPI report—and indicate a pause may be in order come fall, it likely would take some pressure off yields. That would favor growth stocks, make for a longer up-cycle in cyclical stocks and aid longer duration fixed-income assets. Shorter-duration and floating-rate securities would be the ones under pressure. Given the data of late, none of which exhibits cracks in the “sticky” inflation narrative, we just don’t see that happening. Nothing we have seen would suggest the Fed will hold its punches, which means after next Wednesday, investors should remain defensive.

Tags Active Management . Equity . Monetary Policy .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Past performance is no guarantee of future results.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Diversification and asset allocation do not assure a profit nor protect against loss.

Duration is a measure of a security's price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

Growth stocks are typically more volatile than value stocks.

International investing involves special risks including currency risk, increased volatility, political risks, and differences in auditing and other financial standards. Prices of emerging-market and frontier-market securities can be significantly more volatile than the prices of securities in developed countries, and currency risk and political risks are accentuated in emerging markets.

Stocks are subject to risks and fluctuate in value.

There are no guarantees that dividend-paying stocks will continue to pay dividends.

Value stocks may lag growth stocks in performance, particularly in late stages of a market advance.

Variable and floating-rate loans and securities generally are less sensitive to interest rate changes but may decline in value if their interest rates do not rise as much or as quickly as interest rates in general. Conversely, variable and floating-rate loans and securities generally will not increase in value as much as fixed-rate debt instruments if interest rates decline.

Federated Global Investment Management Corp.