Meet a Strategist is a feature where Evan Harp talks to different strategists about how their firms are responding to the current moment. This week, he sat down with Rob Williams, chief investment strategist of Sage Advisory.
Evan Harp: What’s keeping your clients up at night?
Rob Williams: Well, I would say the main thing for this year has been rate concerns given the volatility we’ve had, the level of uncertainty around Fed policy. A lot of our clients are fixed income oriented. This interest rate cycle has not followed the typical pattern. It’s been very aggressive.
I think clients are still shocked from negative fixed income returns in 2022. Market sentiment is very much tied to rates; just look at recent CPI data and the effect on rates. Bad news is good news because it can cause rate pressure to ease and is seen as more of a dovish Fed. But strong data keeps upward pressure on rates and downward pressure on risk assets; so, that kind of higher-for-longer mentality. We do think it’s obviously something to be concerned about. But we think it’s somewhat misplaced in that there’s a short-term and there’s a medium-term view.
We are actually worried less about rates, because even if the Fed has to hike once more, it’s somewhat inconsequential. This cycle is about done. We’ve already gone through the desert. We think we are around fair value or close to peak rates. And over the medium term, I think it’s a good place to start. And with fixed income , you’re getting yields around the 5%-6% range. So, when you start looking out 12 months, it skews returns to the upside.
For risk assets, spreads are tight and equity valuations are high. So, if rates peak, but don’t go down for a while, we would be concerned that higher-for-longer increases the economic risk, right? The longer rates are higher, it increases the downside risk for the economy and equities, and credit spread risk over the medium term. So, while rates are concerning to clients, we don’t believe they’re going to go materially higher to hurt your fixed income side of the allocation from here. I think the headwinds are less than they have been. But higher-for-longer could eventually catch up to consumer and hurt the economy. It could be a bigger risk to the equity side of the portfolio.
Sage Advisory on Recent Allocation Changes
Harp: Have you made any recent changes to your allocations?
Williams: All the changes we’ve made over the last couple months have really been about being more defensive. We do think the consumer is going to fade out. And we do think there’s going to be a soft recession in 2024. So, like I’ve mentioned, we believe the rate cycle is near its peak. It does make sense to push out your maturity, your duration, your interest rate risk on the fixed income side of the allocation. So that’s what we’ve been doing.
We think you want to participate in rate moves back down over the coming 12 to 24 months, which you won’t participate in with cash or very short maturities. You’ll protect your money. But you’re not really hedging the downside risk in the economy or risk assets the way you do when you put some duration on. Where we are conservative with fixed income is with spread risk.
So, we are keeping it somewhat short maturity-focused in our credit side of the allocation, and we are limited in our high yield exposure. One area we like in fixed income that we’ve increased a couple times over the last couple months is mortgage-backed securities. It’s very rare that yields and mortgage backs are on par with credit, right? Usually, you’re giving up some yield to take on that credit risk, though MBS is a little lower yield. So, this is a rare area we’re in that MBS is getting the same yield. And it’s AAA agency-backed MBS that are getting similar yields to BBB credit. But you’re getting higher quality and liquidity without that credit risk. We’ve been adding to that.
On the equity side, we’ve increased our defensiveness, but we want to stay invested in the market, right? This means focusing on some of the lower-volatility sectors. Those are things like healthcare, consumer staples, investing in baskets of lower volatility, like an Invesco S&P 500 Low Volatility ETF (SPLV ), a low-vol version of the S&P, things like the JPMorgan Equity Premium Income ETF (JEPI ), which provides that option element to increase the income but also stay low volatility. So, we’ve pushed those positions up.
And then we favor the U.S. a little bit, because the economic backdrop’s been a little stronger. But we do know valuations are cheaper overseas. So what we’ve done is look for markets that have big discounts to the U.S., which is most markets, but also have good economic prospects and are lower volatility markets on a global scale. In particular, we like Japan, so we’ve increased that position.
Harp: What do you think of the markets right now?
Williams: We are cautious on risk assets and especially equities. I’m optimistic on fixed income overall, though equities continue to power on. I think they have recovered the last few weeks. It’s been a knee-jerk reaction to the fall in yields. I don’t think equities are fully considering the long-term effects of higher-for-longer.
We don’t think the Fed is going to be in the position of cutting rates aggressively in the first half of next year. I think that’s what the markets are starting to gear up for and priced for. We don’t think that’s going to happen. And we think the Fed needs to see much more weakness in the economy and the job market before they consider hiking in the near term or a consider cutting in the near term. So I think the risk/reward is not great. Equities may trade OK into year end. But we think, over the medium term, valuations are stretched. That’s especially when you look at it versus the yield you’re getting in fixed income. The math on fixed income is just better.
The ETF MVPs for Sage Advisory
Harp: Are there any ETFs you’d like to highlight?
Williams: On the equity side, defensive and low volatility, things like consumer staples, things like a basket of low-vol stocks in the S&P 500. It’s a good place to be if you want lower beta in the portfolio.
I mentioned JEPI. It’s also low volatility, but it doesn’t overexpose you to some of the traditional defensive sectors that are in an ETF like SPLV. I think the advantage of JEPI is the low volatility and you’re getting attractive income. I mentioned we like Japan, the JPMorgan BetaBuilders Japan ETF (BBJP ). It’s 19 basis points. Expenses aren’t necessarily the main driver in our selection process. But it’s good core Japan exposure, similar to MSCI Japan, but at a very reasonable expense ratio to get good broad exposure.
And then I’ll just mention on the fixed income side, I mentioned mortgages, there are a couple of choices there — the iShares MBS ETF (MBB ). Janus Henderson has a good mortgage fund, the Janus Henderson Mortgage-Backed Securities ETF (JMBS ). It’s a huge part of the aggregate index, upwards of 30%-plus. We’re over 40% on the fixed income side in our mortgage-backed exposure.
The Thing That Sets Sage Apart
Harp: What’s one thing that sets your firm apart?
Williams: Sage is an institutional bond manager first and foremost. And I think investors of all asset classes appreciate our view and approach. Our multi-asset ETF clients often have balanced accounts of 60/40 or 80/20, with a good chunk of fixed income. So they appreciate the level of expertise that we bring to that side of the portfolio.
A $22 billion AUM bond business gives us certain advantages that we can replicate. All the best ideas we’re implementing thematically and on the macro side are put in on the ETF side, too. So, I think clients appreciate that. And being a fixed income manager also gives us a fuller macro view.
We emphasize rates and policy, and that’s a big driver of our investment philosophy. Fixed income managers look at the downside risk, whereas equity markets are more focused on the upside potential. So, I think for being defensive and navigating tricky markets, people like that we have that fixed income mentality and macro approach.
Harp: What’s something going on in the markets that not enough people are talking about?
Williams: I think investors are more focused on the Fed being done raising rates. They should be focused on the fact that policy has lagging effects with multiple implications. This has been an aggressive rate cycle. And we’re now seeing conditions getting tighter. The idea of higher-for-longer is causing pressures under the surface for the consumer and for companies. This soft-landing narrative has become very entrenched, but policies have lag effects.
We’re seeing things like delinquency rates on consumer loans ticking up. So consumers are feeling pressure. We’ve completely forgotten about quantitative tightening. Global central banks are shrinking their balance sheets. That means shrinking liquidity after years of excess liquidity. This is typically a big pressure on equity markets, and I think it’s largely being pushed aside. Everyone’s excited that the Fed’s going to be done hiking rates. But that doesn’t mean they’re going to be cutting rates. And it doesn’t mean they’re embarking on quantitative easing. It just means they’re not causing you pain.
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