Opportunity in today’s volatility

October 14, 2021

THOUGH MARKETS HAVE CLIMBED STEADILY IN 2021, investors may be wondering whether risks ranging from the Delta coronavirus variant to rising inflation could spell the end of the bull market. Yet while risks abound and periods of volatility are likely in the months to come, “long-term economic fundamentals appear strong enough to weather temporary setbacks,” says Joe Curtin, head of Portfolio Management, Chief Investment Office (CIO), Merrill and Bank of America Private Bank. “In fact, occasional bouts of weakness may provide investors with potential opportunities to rebalance or strategically add to their portfolios.”

A recent CIO Viewpoint paper, “The Rotation Is Underway,” looks at the current market environment and highlights factors that could drive periodic volatility, including higher inflation for longer and potential timing of the Federal Reserve’s (the Fed’s) pull back on bond buying. Still, says Curtin, “markets are likely to grind higher for the balance of 2021 and beyond.” Below he points to five factors that could drive continued growth and suggests strategies that investors might consider.

1. Economic strength. “Solid household balance sheets, strong pent-up demand, robust household and business formation, rising capital goods orders and inventory rebuilding should all add to above-consensus growth,” Curtin says.

2. Corporate profits, revenues and operating leverage are currently performing beyond expectations. “We believe these trends will continue in the fourth quarter of 2021,” he adds.

3. Investors have cash on hand. Though investor sentiment has turned to “slightly concerned,” Curtin notes, many investors have cash that could still be invested.

4. “The cost of capital for corporations is close to record lows and should support rising capital investment,” Curtin says.

5. Greater policy transparency. The Fed has been steadily purchasing bonds to stimulate economic growth during the pandemic. As the economy continues to grow, the Fed is signaling tapering back those purchases. Clear signals as to the timeline for tapering should give markets time to prepare, he notes.

What all of this could mean for your portfolio

While investment decisions should always be made in the context of your personal goals, time horizon, liquidity needs and long-term strategy, the coming months may offer investors opportunities to rebalance or add to their portfolios across asset classes, Curtin notes.

Stocks. The economy is likely to continue to grind higher for the balance of 2021 and beyond, believes Curtin. That’s why the CIO continues to favor equities over fixed income. “Stocks of large U.S. companies may be particularly attractive, thanks to their combination of high quality, dividends and potential growth,” Curtin says. “Periods of volatility may be a good time to consider adding sectors such as financials, industrials, energy and materials, which could likely benefit from the continued economic recovery,” he adds. “Meanwhile, technology companies remain attractive amid a rise in spending on innovation, productivity and digitalization of the economy.”

Current conditions favor investing in a mix of growth and value stocks that would simultaneously gain from cyclical and secular forces gaining traction, Curtin says. Growth stocks — companies with the potential to grow and outperform overall markets — should likely benefit from accelerated secular investments in 5G, artificial intelligence, cloud computing, robotics, demographics and health infrastructure globally. Value stocks — companies that have higher exposure to cyclical sectors — are likely to benefit from improved earnings growth and economic normalization. “We also favor the U.S. equity markets over the rest of the world,” he notes.

Bonds. Fixed income investors may want to consider bonds with shorter rather than longer duration to offset the potential effects of inflation, which has been consistently running above the Fed’s 2% target. “Though the market believes any further increases in inflation will be transitory, we do need to be prepared for an elevated level of inflation driven by easy monetary policy, supply chain issues and supply-demand imbalances for goods as well as services,” says Curtin.

Because their rates have been declining recently, Treasurys may be attractive to investors mainly as a way to balance stock risks in their portfolios, he adds. Investors seeking higher yields may want to consider high-quality corporate bonds. “Investment-grade corporates should continue to outperform Treasurys as the global economic recovery continues to play out.  However, taxable investors may want to consider municipal bonds,” he suggests. Shortening duration could help to mitigate some impact from rising interest rates.

Alternative investments. Qualified investors may want to capture long-term opportunities through alternative investments such as hedge funds, private equity and other strategies, which could help them capitalize on potential opportunities not available through traditional stocks and bonds, Curtin says. Yet alternative investments should be considered only by qualified investors with complex and specific investing needs, he adds.

Regardless of which investments may be appropriate for you, ask your advisor what you can do to prepare for markets poised to grind higher during the rest of 2021 and beyond, he suggests.