We have adjusted U.S. sector exposure in the Global Conservative strategy by reducing our overweight of Information Technology and adding to Consumer Discretionary exposure, which now represents a material overweight. We have also shortened the duration (interest rate sensitivity) of the strategy’s fixed income allocation by eliminating longer-term Treasury bond exposure and adding to intermediate investment-grade corporate bond exposure. While our broad economic outlook has not changed significantly, we do see potential for modest increases in longer-term interest rates, which could pressure extended equity valuations and weigh on longer-term Treasury bond returns.
Outlook Update: Our economic outlook, overall, has not changed significantly. We continue to see signs of a mature cycle in the US, but we also expect moderate growth to continue and the U.S. consumer to remain the highlight of the U.S. economy. However, our interest rate outlook has shifted modestly. With continued economic growth and diminished likelihood of a full blown U.S./China trade war, we anticipate real interest rates will move up from near cycle lows and a modest uptick in inflation will put upward pressure on longer-term interest rates. Further, we see elevated asset valuations moving to the top of the Fed’s risk list and, while we do not expect the Fed to raise short-term interest rates, we would not be surprised to see the Fed’s messaging turn less dovish in an attempt to talk down extended valuations.
Reduction of U.S. Information Technology/Increase of U.S. Consumer Discretionary Equity Exposure: Strong U.S. equity market performance since early 2019 was driven almost entirely by valuation expansion. Since the beginning of 2019, the forward P/E ratio of the S&P 500 as a whole moved from about 14.5x to about 18.5x. The U.S. Information Technology equity sector significantly outperformed over that period, and its P/E moved up from about 18.0x to about 22.2x (at the high end of its historical range, excluding the Technology bubble of the late 1990s). The U.S. Consumer Discretionary equity sector is more reasonably valued, in our view, especially when accounting for the impact of its largest constituent, Amazon.com, which we believe is well positioned given continued strength in e-commerce, strength of the U.S. consumer, and the secular trend toward cloud computing. We believe the U.S. Information Technology and Consumer Discretionary equity sectors are both fundamentally advantaged in the current economic environment, and despite reducing U.S. Information Technology equity exposure, we remain overweight to the sector. However, the risk of a modest increase in longer-term interest rates could put pressure on extended equity valuations, which could weigh more heavily on U.S. Information Technology equity sector returns.
Shortening of Fixed Income Duration/Increase of Investment-Grade Corporate Bond Exposure: We have eliminated longer-term Treasury bond exposure, modestly increased intermediate Treasury exposure, and added intermediate investment-grade corporate bond exposure within the Global Conservative strategy’s fixed income allocation. This shift reflects the evolution of our interest rate outlook, which now anticipates increased risk of a modest rise in longer-term interest rates, driven by a mix of rising real rates, a likely modest uptick in inflation as moderate economic growth continues, and the potential for less dovish rhetoric from the Fed as the risk of a full-blown trade war with China has eased. Given the potential for a modest steepening of the yield curve as longer-term interest rates rise, we believe shortening the duration (interest rate sensitivity) of fixed-income exposure is warranted. With our expectation for continued moderate economic growth, we believe adding intermediate-term, investment-grade corporate bond exposure is appropriate in conjunction with lowering the overall duration of the fixed-income allocation.