Q4 Intra-Quarter Portfolio Rebalance

On Friday November 15, 2019, our BlackRock model guidance prompted us to do a Q4 intra-quarter portfolio rebalance. Thus, you may have received trade notifications associated with this firm-wide rebalance. Below are notes from the “BlackRock to Advisor” Podcast that review the reasons for the portfolio rebalance. Additional trade rationale research notes are also included.

“When the facts change, I change my mind. What do you do, sir?”

The portfolios are re-positioning outside of their regular rebalance frequency for the first time in over 3 years. The asset allocation views at the beginning of October now require an adjustment, as the market has greater clarity on some of the year’s great uncertainties, namely the path of the Fed, Brexit and the trade war. The asset mix between stocks and bonds is unchanged, but portfolios are switching from a defensive to a more cyclical positioning.

“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.”

The reality is that while peak trade uncertainty passed in September, the pathway to resolution was too difficult to envision. Since then, the cocktail of domestic political pressures and sticking points in a resolution framework have begun to fall away. To quote the economist Rudi Dornbusch, “It took forever and then it took a night,” and this is now the risk facing the portfolios – rapid resolution seems more likely than escalation. In the equity section, this means a reduction in minimum volatility in favor of low size equities, and moving emerging market exposures further overweight, funded from developed markets.

“Politics is not the art of the possible. It consists in choosing between the disastrous and the unpalatable.”

Looking ahead to 2020, keeping the expansion rolling is of paramount importance for an incumbent President with impeachment proceedings in the background, regardless of the concessions on offer from China. Armed with far lower hard Brexit risks, accommodative policy from a hyper-sensitive Fed, and now finally cutting the risks posed by trade war escalation could serve as one of the great catalysts for a more cyclical rally. This is not to say that the global economy is out of the woods yet, but we think a clearing is in sight. Overall, this rebalance reflects a desire to move before the gains on the defensive rally are gone and also capture a potentially new regime.

TRADE RATIONALE FOR PORTFOLIO REBALANCE

Asset Allocation: We have become more optimistic and are positioned in favor of riskier assets. Many of the major obstacles for continued growth and expansion are in the process of being removed. The strong rally in defensive assets could now pivot towards more cyclical exposures. With geopolitical risk fading as the global consumer remains resilient, the prospect of a resumption in delayed capital investment can power earnings. To balance the more cyclical stock exposure for the time being, we are maintaining our current exposure to longer-duration treasuries and limited exposure to credit spreads.

U.S. Equity: We maintain an overweight to US stocks across the portfolios, while lowering some of the US equity weight overall. Our earnings estimate revision signals relatively favor the US over Developed Markets, but now also favor adding to EM. Factor allocations are shifting markedly in favor of cyclicality, adding stocks exhibiting the low size factor and to the existing position in quality factor stocks. Minimum volatility stocks have performed well thanks in part to multiple expansion – and we believe this wave may be behind us, with expansionary impulses driving the market more from here.

International Developed Equities: We increase our underweight position to international developed markets. Aggressive regional central banks could provide a boost to the region, but the equity market is still dogged by below average earnings prospects until the growth trajectory shows signs of a turnaround.

Emerging Market Equities: Our outlook for emerging market equities shifts to an overweight stance. Armed with helpful starting valuations, and potentially a significant catalyst in the form of a US/China trade resolution – our outlook for corporate earnings in the region becomes even stronger. Macro risks have largely been confined to trade. We believe that supportive monetary policy combines with an uptick in risk appetite and positive estimate revisions to give EM return potential over the near-term.

Fixed Income: We remain underweight in bonds relative to stocks. In a strong year for spread products, the trend of credit spread compression and falling long end rates may continue under a positive trade scenario, but we expect further gains to be incremental, and prefer to take risks around cyclicality in the equity portion of the portfolio.

Posted 11/18/19

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