On June 17th we sent out a blog highlighting the new accommodative stance by the Federal Reserve. We equated that shift to the 1995 policy execution which acted as an insurance easing at mid-cycle. We concluded our blog with the following statement: “Ultimately, everything hinges on avoiding a major political mistake, but a dovish Fed is every investor’s best friend.”
And that is the current issue: the probabilities of major political mistakes have significantly increased and that is pushing the Fed into a corner by forcing an easing policy more aggressively than they would like or that it may be needed. The market is adjusting to this new risk environment and money is flowing into the perceived safety asset such as the US 10-year Treasury. However, a bond yield at barely above 1.5% is generally not healthy for the economy, it creates distortions, and in the long run it may not provide much safety at all in terms of returns. Funds are also flowing into other areas deemed sheltered by this convergence of factors such as REITs. Publicly listed real estate has long been a favorite of ours but it is currently expensive, a factor that limits future expected returns. Gold is also acting as it should by providing a hedge against increased volatility.
As far as areas of value, unfortunately the landscape does not offer many opportunities outside of specific single company situations. One area that is persistently in value mode is energy midstream assets which should show a lower correlation to the market during defensive periods. Disappointingly, the midstream sector is again showing stronger correlation to the volatile commodity prices rather than conforming to its utility like profile. We were on a call yesterday with a dedicated sector analyst who reiterated the value proposition in the sector and positive long-term story underpinned by the switch to the generally self-funding model, higher coverage of distributions and lower leverage. The analyst also indicated a perking institutional interest especially among insurance companies.
From a technical perspective, we are not hitting extreme datapoints yet and a little more pressure might be needed before reaching a short-term oversold level.
Overall well-planned long-term allocations should not be significantly altered although we should be mindful that expected rates of returns on most assets will probably be lower than what experienced in the past few years and highly influenced by the development of significant policy decisions.