As the Federal Reserve introduces the first round of rate cuts, markets are attempting to come to grips with a new investment paradigm, which is showing signs of cooling.  Despite the recalibration of our portfolio, we’re not abandoning ship. Looking beyond the immediate horizon, our medium-term outlook remains cautiously optimistic, with a view that recession odds remain low in the near term.

The current market conditions continue to show a preference for stocks over bonds.  By extending some duration to the models, the committee is looking to lean into an improved diversification role of core bonds, setting the stage to potentially capitalize on the opportunities that frequently emerge in the wake of a rate cutting cycle.  Our research also reveals the autumn period from mid-September through early November in presidential election years has tended to be more volatile than usual, with increased vulnerability to sharp downside moves. The elevated uncertainty surrounding the upcoming election adds additional complexity that is difficult to handicap. Given the sharp divide in the parties’ expected policy, and the expectations of a close race, many real economy actors are delaying major capital allocations and business-defining bets to after election night. In this state of uncertainty any lack of liquidity has the potential to trigger significant market fluctuations and is compounded by the chance of delays or prolonged uncertainty about the outcome.  A relatively tranquil melt up in mega cap stocks the first 6 months of the year was disrupted by history-making single-day selloffs, rotations, and V-shaped snapbacks, telltale signs of a market more susceptible to headline-induced downdrafts.

The LSA Investment Policy Committee; will be implementing model updates to the mutual fund, and ETF models.  These changes will be released early October with a planned review of variable annuity models to follow.   Below you will find a breakdown of the upcoming changes:

• Posted Tuesday, October 1^st – ETF, ETF Tactical, PC IQ, Private Client Blended, Private Client Traditional, Private Client, Private Client Tax Efficient, Bear Market Entry, Cautious Bear Plus, and Private Client L100k – targeted model update – Tuesday, October 8^th.

*The mutual fund model revisions impact the NTF models as well.

*As a reminder, the Revision Explanation Presentation/Video will be posted in the “Portfolio News” section on each of the platform home pages.

Investment Rationale Note: Cautiously Optimistic Amid Rate Cuts and Economic Uncertainty

As the Federal Reserve moves toward a rate-cutting cycle, signaling a shift in monetary policy, investors are faced with a complex economic environment that requires both caution and strategic allocation. Inflation, while cooling from its recent highs, remains persistently above target levels, adding layers of uncertainty to the broader outlook. At the same time, we are observing a deceleration in key economic indicators, particularly in labor markets and consumer spending. This slowdown, coupled with the heightened potential for volatility as we approach a contentious election cycle, calls for a balanced yet optimistic approach to portfolio management.

Now that the Fed has implemented the first rate cut in September, extending duration exposure to bonds in the models becomes a timely opportunity. With rates poised to fall, the relative value of longer-duration bonds will likely improve, benefiting from a more accommodative monetary policy. This move should not be seen as a wholesale shift away from risk assets, but rather as a tactical adjustment to enhance diversification. By adding duration to fixed income holdings, we create a buffer against potential equity market turbulence, a diversification impact that has seemed non-existent over the last several years but looks to be adjusting to more historically low correlation impact, while capturing value in a sector that had been under pressure during the rising rate environment.

While inflation is cooling, it remains stubbornly high, suggesting that the Fed’s monetary easing will be gradual and measured. This inflationary backdrop still creates headwinds for some asset classes, particularly those sensitive to input costs. However, diversified allocation exposures across various sectors could continue to offer growth potential. This includes sectors and alternatives that have demonstrated resilience in this high-inflation, lower-growth environment, and should remain key components of any long-term equity allocation.

In equity markets, despite slowing economic data, the long-term outlook remains constructive, especially when considering the historically positive impact of rate cuts on stock performance. A continued long-equity bias within our models reflects this outlook, particularly for growth-oriented companies that stand to benefit from both lower borrowing costs and eventual economic stabilization. Maintaining exposure to equities, particularly in sectors poised for secular growth, aligns with a cautiously optimistic stance, even as we acknowledge shorter-term volatility risks.

Finally, the looming election cycle introduces the potential for market turmoil, as political uncertainty can exacerbate volatility across asset classes. However, risk-controlled models could help mitigate some of these concerns by providing structured exposure to risk while focusing on capital preservation. Allocations toward defensive assets, such as dividend-paying stocks, alternative strategies, and quality bonds, combined with selective duration extension, potentially allow us to manage downside risk without compromising on the opportunity for growth.

The investment landscape demands a balanced approach, leveraging the advantages of a dovish Federal Reserve, while navigating persistent inflation and slowing economic data. By making thoughtful adjustments in duration exposure, identifying good performers across asset classes, and maintaining a long-term equity bias, we aim to position portfolios for growth in a cautious yet optimistic manner, with a keen eye on managing risk in the months ahead.

As we navigate these uncertain waters, let’s remember the words of Aristotle: “Patience is bitter, but its fruit is sweet.” The market rewards those who manage risk with foresight and conviction.

Here are the core themes: 

1. Fixed Income – with the recent ‘inflation fade’ the IPC is looking to take some gains from some of our shorter duration inflation protected exposures.  Historically, as the Fed begins down a path of rate hikes, or in the cycle we currently find ourselves, rate cuts it is uncommon for the Fed to change course.  It is with the understanding that the Fed looks to cut rates over the near term that the committee is looking to lean into an increased duration exposure.  It appears as though the diversification impact of core bonds had started to improve.  The role of bonds can vary from preservation of principal, growth with income and diversification.  There are various bond solutions that target each of these roles, however the role targeted with these model adjustments are with an effort improve the diversification impact to help hedge future equity volatility. 
2. Manager Selection – it is important to revisit all positions to make sure that we continue to have the appropriate manager in place for the role they play in the models.  There are a number of investments available and we utilize these model updates as an opportunity to revisit all the underlying positions that make up a model, and make sure that we continue to have a meaningful manager or position that is bringing skill and value to the strategy.