2. Let bonds be bonds
Continuing the themes discussed in our mid-year outlook, bond exposures can potentially offset equity risk within the portfolio. However, not all bonds are the same. Below investment grade credit has become highly correlated to equities. The curve has flattened and long-term rates have fallen so dramatically that the yield per unit of duration is sub-optimal to more intermediate parts of the curve. Therefore, given the late-cycle dynamics in play, active and intermediate-duration bond strategies can offer the potential for increased income and return without uncompensated duration or equity-like risks.
3. Strike a defensive tone
Finally, gold typically performs well when volatility spikes. Gold has appreciated +6.7% on average during the last nine market downturns, while the S&P® 500 Index has pulled back an average of -13.3%.1 That same trend has continued so far this year, as gold prices broke through the psychological 1,500/oz. barrier on the back of persistent geopolitical tensions and real interest rates turning negative. Gold has historically had a negative relationship to real rates.2 Both factors may continue to support gold prices. The rate environment is unlikely to change, given the stance by multiple central banks to lower rates and turn policy overly accommodative to combat sluggish global growth concerns. Additionally, the geopolitical issues are unlikely to go away given the uncertainty around trade, Brexit, and ongoing strife in the Middle East (e.g., Iran) and Asia (e.g., Hong Kong).
Picking sector winners and losers in trade uncertainty
US-China trade negotiations continue to be a random walk. The threat of tariffs and Chinese Yuan devaluation point to a prolonged environment of trade and economic uncertainty. The US-China trade relationship impacts a broad range of US businesses and their overseas operations, driving market sentiment. However, dispersions between sectors and industries exist. Taking a moment to get under the hood and look at exposures is a good way to find opportunities to pivot to those areas that are potentially less impacted by negative developments on the trade front.
1. Technology: Avoid companies that have high revenue exposure to China or have supply chains that are heavily dependent on Chinese exporters.
Key takeaway: Not all technology runs through China. Software and IT service companies, for example, have lower revenue exposure to China and are less dependent on foreign supply chains.
2. Financials: It's no secret that financials have underperformed recently, driven by falling yields and curve flattening on the back of a negative economic outlook, but insurance companies have shown greater resilience.
Insurance stocks have historically been less sensitive to yield movements and less volatile than companies in other financial industries.3 In addition, financial firms’ businesses and operations are less exposed to tariffs and global trade. From a fundamental perspective, insurance companies’ earnings growth and sentiment have been strong as well.4
Key takeaway: For investors who favor financials’ domestic-oriented business amid trade uncertainty but want to mitigate negative impacts of falling interest rates, the insurance industry may be an ideal place to be.