Strategies for a new rate reality

Key Takeaways 

• The U.S. is entering a rate-cutting regime. 
• Strategies that worked in recent years may not work going forward. 
• U.S. equity valuations are high but they are lower internationally. 
• Fixed income duration – the market has been very short duration, may make sense to add duration back into the portfolio. 
• Sectors in Focus: Utilities, Consumer Staples. 

Why invest in US small- and mid-cap equities? 

Smaller US companies are the lifeblood of the US economy. While they don’t get the same sort of media exposure as Apple or Microsoft, these companies span the gamut from agricultural and construction machinery to airplane parts to specialty chemicals and everything in between. These companies also have a bias toward the strong US economy, and they should benefit from the “onshoring”/”reshoring” of US industries. 

A recent shift in U.S. rate strategy could significantly alter market leadership and investment strategies. Understanding how to navigate this changing landscape is crucial for investors looking to optimize their portfolios while maintaining a disciplined approach. 

The U.S. Federal Reserve's (“Fed”) 50 basis-point reduction in its target rate on September 18 ushered in a new era for the U.S. economy. The change represents a sharp pivot from recent years, which was marked by a steady tightening of financial conditions, pushing short-term interest rates to levels exceeding 5%. Now, with the tide turning, investors face a vastly different environment where market drivers could be fundamentally altered. 

For investors, the challenge lies in predicting what might work "this time around." With interest rates heading downward, business sectors that once thrived may face headwinds, while others that struggled could begin to shine. Staying disciplined and maintaining a well-thought-out asset allocation strategy becomes even more essential in such uncertain times, as this ensures that the risk/return profile of an investment portfolio remains aligned with its objectives. 

Importance of Asset Class Mix 

The most significant determinant of portfolio risk is the asset class mix—the allocation of investments across equities, fixed income, commodities, and other asset types. As the largest driver of portfolio performance, ensuring that the asset mix remains aligned with investment goals is critical. An optimal asset allocation strategy must adapt to changing market conditions, especially in response to major policy shifts like the current rate-cutting regime. 

A diversified asset mix allows investors to mitigate risk while optimizing returns. Amidst uncertainty, having exposure to different asset classes enables portfolios to withstand volatility and capitalize on opportunities that emerge across the financial landscape. 

Fixed Income: A Core Component 

Incorporating fixed income into a portfolio serves as a stabilizing force, particularly in times of economic uncertainty or during shifts in monetary policy. However, recent years have shown that not all fixed income investments perform equally across various stages of the economic cycle (see chart below). Different segments of the fixed income curve—such as short-term versus long-term bonds— can present both opportunities as well as risks at different times. 

However, by maintaining broad-based fixed income exposure, investors ensure that some portion of their fixed income allocation is consistently “working” regardless of market conditions. This broad approach provides flexibility for active investors to make tactical tilts, allowing them to adjust exposures according to their views on interest rates, inflation, or economic growth. For instance, in a declining rate environment, investors might prefer longer-duration bonds that tend to gain value as rates fall.

Geographic Diversification 

On the equities side, geographic diversification emerges as a powerful tool for managing risk. By spreading investments across different regions, investors reduce exposure to market-specific or idiosyncratic risks that can be tied to political, economic, or regulatory factors. This diversification approach can help smooth out portfolio performance, even when certain markets face turbulence. 

It is important to note that valuation measures, while useful, do not necessarily predict a stock's short-term movements. A stock can remain overvalued or undervalued for an extended period without an apparent catalyst. However, valuations hold considerable predictive power over the long term, providing valuable insights into future return expectations. By maintaining a geographically diversified portfolio, investors can ensure they already have exposure to those “cheaper” regions as valuations begin to normalize. 

Sector Considerations 

When interest rates fall, specific sectors tend to benefit more than others. Historically, rate-sensitive sectors such as utilities and consumer staples have performed well in declining rate environments. This outperformance is often due to these sectors' relatively high dividend yields, which become more attractive as bond yields fall. Additionally, lower borrowing costs can enhance profitability for companies in these sectors, making them more appealing to investors. 

However, it is not just the rate-sensitive sectors that stand to gain. Economically sensitive sectors like energy and financials can also do well in a rate-cutting environment. For example, lower interest rates often lead to increased consumer spending and business investment, driving demand for energy. Similarly, financials may benefit from a steepening yield curve, which can improve the profitability of lending activities. 

Core Investment Principles 

The current shift towards a rate-cutting regime underscores the importance of maintaining a disciplined investment strategy. Despite the temptation to chase trends or make impulsive changes in response to market fluctuations, investors should prioritize sticking to their asset allocation plans. This disciplined approach ensures that portfolios remain balanced, aligned with long-term investment goals, and protected against taking excessive risks. 

The Fed’s new monetary policy era is prompting investors to reassess their strategies. In this environment, maintaining a diversified portfolio that includes broad-based fixed income and geographically diverse equities is essential. Rate-sensitive sectors like utilities and consumer staples, as well as economically sensitive sectors like energy and financials, may offer potential opportunities. The key to navigating this changing landscape is staying disciplined, sticking to asset allocation strategies, and adapting to market shifts. 

The views/opinions expressed herein are solely those of the author(s) and may not necessarily be the views of Global X Investments Canada Inc. All comments, opinions and views expressed are generally based on information available as of the date of publication and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors. 

This communication is intended for informational purposes only and does not constitute an offer to sell or the solicitation of an offer to purchase investment products (the "Global X Funds") managed by Global X Investments Canada Inc. and is not, and should not be construed as, investment, tax, legal or accounting advice, and should not be relied upon in that regard. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors should consult their professional advisors prior to implementing any changes to their investment strategies. These investments may not be suitable to the circumstances of an investor. 

Certain statements may constitute a forward-looking statement, including those identified by the expression “expect” and similar expressions (including grammatical variations thereof). The forward-looking statements are not historical facts but reflect the author’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward-looking statements. These forwardlooking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law. 

Global X Investments Canada Inc. (“Global X”) is a wholly-owned subsidiary of Mirae Asset Global Investments Co., Ltd. (“Mirae Asset”), the Korea-based asset management entity of Mirae Asset Financial Group. Global X is a corporation existing under the laws of Canada and is the manager, investment manager and trustee of the Global X Funds. 

© 2024 Global X Investments Canada Inc. All Rights Reserved.