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Weekly CIO Commentary
A blast from the past
Bottom line up top:
- Banking pressures could persist. The failure of Silicon Valley Bank has sparked broader market volatility, especially across regional banks, even though this is a niche bank focused on venture capital, and is not representative of the broader banking sector. While bank depositors should be protected given policymaker actions, bank equity and bond holders could see additional downward pressure, especially as higher interest rates act as a headwind for the banking system.
- Higher for longer… or is lower simply over? The ultra-low-rates environment investors have grown accustomed to seems to be ending. But a look back at the fed funds effective rate suggests we are not at risk of leaving a period of normalcy, but rather a period of irregularity (Figure 1). Since the Fed began lowering rates during the Global Financial Crisis in July 2008 until the current rate hiking cycle started in March 2022, the average yield on an overnight deposit between lending institutions was just 0.7%. In the half-century leading up to the Global Financial Crisis, the average rate was 5.7%.
- Recency bias is the term describing the assumption that the current state of being will continue indefinitely. As we face the potential end of an era of easy money, prudent investors should be prepared to adjust their portfolio construction from what has worked over the last decade. Even the traditionally idealized 60/40 split between equity and fixed income allocation is under scrutiny, as correlations between the two asset classes have risen significantly. Rather than fearing change, average investors should consider how they may benefit as asset classes that were once off-limits to some are now more accessible.
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The traditionally idealized 60/40 split between equity and fixed income is under scrutiny, as correlations have risen significantly.
Portfolio considerations
Higher-for-longer interest rates are an important factor in portfolio construction. Inflation may to top 3% annualized over the next five years, according to Moody’s Investor Service. Equities and bonds have experienced negative returns in such an environment (Figure 2). That does not make investing in public markets unattractive, but it requires more selectivity.
Within equities, this environment favors areas that have historically thrived during periods of higher inflation, including industrials and the materials sectors that benefit from higher commodity prices. Historically, commodities have returned almost 2% each quarter when annual inflation is more than 3%. As for fixed income, investing in plus sectors such as senior loans and high yield will likely be required to earn a real yield, after inflation, inside a portfolio. High yield corporate bonds may provide an attractive total yield (the risk-free rate plus a spread for taking on credit risk). Senior loans offer investors a floating – rate yield that may protect a portfolio from further rate increases.
Inside alternatives, private real estate and farmland have performed well during higher inflationary periods. Thanks to their longer-term leases, farmland investments tend to hold their value in real terms and provide income stability.
Looking ahead, investing in public markets will require more selectivity.
Nuveen’s Global Investment Committee (GIC) brings together the most senior investors from across our platform of core and specialist capabilities, including all public and private markets.
Regular meetings of the GIC lead to published outlooks that offer:
- macro and asset class views that gain consensus among our investors
- insights from thematic “deep dive” discussions by the GIC and guest experts (markets, risk, geopolitics, demographics, etc.)
- guidance on how to turn our insights into action via regular commentary and communications
Related articles
Access previous issues of Saira Malik’s weekly CIO commentary on strategy and portfolio construction.
U.S. Treasury yields to fall steeply amid heightened economic and financial uncertainty.
The U.S. Federal Reserve hiked rates, as expected, at today’s policy meeting.
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Sources
All market and economic data from Bloomberg, FactSet and Morningstar.
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation to buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.
Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible. Investing involves risk; principal loss is possible. All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
Important information on risk
Investing involves risk; principal loss is possible. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk, and income risk. As interest rates rise, bond prices fall. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity, and differing legal and accounting standards. These risks are magnified in emerging markets. Non-investment-grade and unrated bonds with long maturities and durations carry heightened credit risk, liquidity risk, and potential for default.
Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies.
Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy.
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