Alan Greenspan says don’t kid yourself, if the bond market blows up the collateral damage to equities could be extensive. But does that mean you need to bail from the market completely?
Blueprints are starting to surface from Wall Street’s brightest minds on how to manage a portfolio should the Federal Reserve withdraw more stimulus and interest rates rise. It’s an issue that was brought to the fore this week when the former Fed chairman warned that fixed-income markets are in a bubble whose deflation will have implications for all assets.
To be sure, the larger part of professional investment opinion is that people should stay in equities. The average projection of 20 strategists tracked by Bloomberg calls for the S&P 500 Index to finish 2017 at 2,488, compared with an average estimate of 2,362 in January and Friday’s 2,472.10 close. But that hasn’t kept thoughts from turning to exit strategies.
Here’s a sampling culled from recent pronouncements from some of the biggest influencers.
Nikolaos Panigirtzoglo, JPMorgan Chase & Co.
Panigirtzoglo, a strategist who advises clients on global asset allocations, says Aug. 21 and 24, 2015, are dates that loom large among investors, a stretch in which concern about quantitative tightening from China sent the S&P 500 to a peak-to-trough swoon of 8 percent. It’s one reason open interest in calls on the CBOE Volatility Index — a bearish equities trade — recently outnumbered puts by 4-to-1.
“Our client conversations over the past few weeks have been dominated by the impending reduction of quantitative stimulus by the ECB and the Fed as the main risk markets are facing into the autumn,” Panigirtzoglo wrote in a July 28 note. “As we approach September, the perceived likely timing of balance sheet shrinkage by the Fed and/or ECB tapering, investors have already started reducing their net exposure to risky markets via hedges in order to protect themselves against a repeat of the August 2015 correction.”
Savita Subramanian, Bank of America Merrill Lynch
The firm’s head of U.S. equity and quantitative strategy said any big jump in rates will prompt selloffs across asset classes, but the pain won’t be equally shared. The worst place is bond-surrogate equities such as utilities — “sell stocks that look like bonds and buy stocks that look like stocks,” she said in an Aug. 1 conference call. Avoiding high-leverage industries is also a good idea.
“The best way to look for yield in an environment when interest rates are rising is not high dividend-yielding stocks, but stocks that have a reasonable yield, above average,” Subramanian said. “What you find here is a lot of cyclical companies that have a discipline of paying some of their earnings in the dividend. We see that in a rising interest rate environment that’s the best spot to be in order to get income.”
Dennis DeBusschere, Evercore ISI
The New York boutique’s head of portfolio strategy isn’t as optimistic as others. He sees the S&P 500 ending the year at 2,300, down 7 percent from its level now. But he’s also realistic about valuation as a timing tool, noting that price-earnings ratios in the S&P 500 have been elevated for 18 months with no ill-consequences for bulls. Still, multiples are higher than either monetary policy or growth would ordinarily justify, increasing risks should either shift. That might show up first in momentum stocks.
“The relationship between bond yields and price momentum has become increasingly negative over the past few years,” DeBusschere wrote in a July 31 note. “Price momentum has been the best performing factor YTD, but underperformed over the past two weeks, a trend that further increases in bond yields would exacerbate.”