Preparing portfolios for more volatility
Following past microbursts of volatility, fiscal or monetary has typically come in to try to keep the good times going. This time is no different in that respect. The Federal Reserve announced an emergency rate cut March 3. If the cut offsets some of the growth shocks anticipated by the impact of the coronavirus disease 2019 (COVID-19), the yield curve could steepen and long-term rates may rise. In such an environment, US Treasuries may not be an ideal choice for balancing upside and downside growth risks. Mortgages may be one area to consider for generating income and mitigating equity risk—without extending on duration.2
A Fed rate cut will certainly not stem the spread of COVID-19, but it will lower the cost of capital and free up more money in the system to offset business impact from a shift in consumer behavior. Yet even with the Fed’s latest emergency rate cut, investors should expect more volatility in the days ahead. The uncertain nature of the virus’s impact is not transitory and will have noticeable impacts for 2020 economic and fundamental trends.3
How to ensure discipline in times of stress like these? One way may be to construct diversified portfolios in an effort to earn the equity risk premium, while also seeking to mitigate the microbursts of volatility prevalent in our current environment. Owning bonds, defensive equities, or uncorrelated assets like gold alongside broad beta in a screaming bull market is hard—until it isn’t. After all, diversification aims to work 60% of the time, every time.4
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