Is the coast clearing for portfolios?

What you need to know

  • A dramatic drop in interest rates brought joy to portfolios as we entered the holiday season.
  • Signs of moderating inflation and softening growth helped clear the coast for the recent broad-based rebound, but we expect bouts of volatility to continue.
  • Review your allocations to some markets that have trailed this year, as well as equity sectors that could benefit from the resilient consumer.
  • We also recommend tilting toward high-quality longer-term bonds and limiting credit risk to help prepare for the coming months.

Portfolio tip

One way to help manage your portfolio’s sensitivity to interest rate movements is by allocating to different asset classes, equity sectors and bond maturities.

Where have we been?

A dramatic drop in interest rates propelled portfolios near year-end. If there was any doubt, market action in November highlighted what investors had placed toward the top of their holiday gift lists: a desire for inflation to trend lower without material damage to the economy. Recent data on inflation, the labor market and consumer strength indicate this may be in the package for 2024.

Interest rates responded to the data with steep declines, particularly in longer-term yields, as markets priced in moderating growth and a greater likelihood that central banks have finished their policy tightening. With interest rates lower, and with signs their peak may be in the rearview mirror, the coast cleared for a market rally across stock and bond asset classes in November. Following the rally, all asset classes we recommend are in positive territory this year, lifting portfolios as we approach year-end.

The stock rally was broad-based, but large-cap stocks hold the lead year to date. Equity asset classes of many sizes and regions participated in the recent rebound, as investors leaned into riskier segments of the market. One-month equity returns were not only robust, but also relatively even across asset classes.

U.S. mid-cap stocks were up 10.2%, followed closely by developed international small- and mid-cap stocks, which returned 10.1%. With China growth concerns still weighing on emerging markets, emerging-market equities fell behind, though they still jumped an impressive 8% in November. All other equity asset classes were within the 8%–10% range.

U.S. large-cap stocks have held on to the lead in 2023, producing over 20% returns. A narrower growth segment of the U.S. market, including mega-cap technology stocks, has driven large-cap asset class higher, however. This is important to consider when evaluating the performance of a well-diversified portfolio. Growth-oriented U.S. large-cap stocks have returned nearly 37% this year. More specifically, U.S. large-cap technology stocks have risen 52%.

Bonds bounce, recouping some of the previous years’ losses. The meaningful drop in yields propped up bond markets in November, helping bond investments recover some of the drawdown experienced over the past three years. With credit spreads tightening and international yields also moving lower, bond markets across credit quality and regions generally performed well, providing support to well-diversified portfolios.

Riskier segments of the bond market outperformed higher-quality bonds in November. Among them, emerging-market debt jumped 5.3%. U.S. high-yield bonds were 4.5% higher for the month and continue to lead bond asset classes this year. They’re up nearly 10% with one month remaining in 2023.

Following last month’s upbeat performance, U.S. investment-grade bonds are now up 1.2% year to date. That said, the asset class has been the biggest drag on portfolios over a three-year horizon, given the weight of rising rates.

What do we recommend going forward?

Asset class diversification may help you navigate volatility. Cash-like investments have risen to the top over two years. But investors who have been overweight in cash this year may have missed out on bigger gains within equities and higher-yielding bond investments. Also, higher interest rates have increased the appeal of investment-grade bonds, despite the more recent drop in yields.

There will always be uncertainty in the markets. Rather than waiting to see a completely clear coast, reevaluate your diversification to help manage volatility and keep you aligned with your comfort with risk and financial goals.

Complementing your portfolio with neutral allocations to asset classes that have trailed this year may help you prepare for 2024. Review allocations to small-cap equity, international equity and higher-quality bonds, for example. Enhancing your diversification may help position you for a broader rebound.

Benefit from the resilient consumer. As we entered the holiday shopping season, consumers continued to display some strength. While we expect that strength to soften in the coming months, we also believe some weakness is already reflected in market pricing.

Given these dynamics and our expectation for inflation to moderate, we’ve raised our recommendation for the communication services sector to overweight. This complements our existing overweight recommendation for the consumer discretionary sector. We expect both sectors to benefit from consumer demand for the time being.

To offset these overweight recommendations, we recommend underweighting financial services. We expect the sector to be pressured by the interest rate environment, as well as tighter credit standards.

Lock in the benefits of higher rates, and limit credit risk. We expect inflation and growth to moderate throughout 2024, likely causing interest rates to drift lower over time. In this environment, we recommend overweighting higher-quality long-term bonds (such as long-term government bonds) within your investment-grade bond allocations. They’re generally more sensitive to interest rate movements than short-term bonds. With the potential for central banks to lower rates next year, this can also help you limit reinvestment risk — when you’re ready to reinvest the proceeds of maturing bonds but interest rates have dropped.

As economic growth softens, we expect credit spreads to widen. When this happens, it pressures corporate bond returns in your portfolio. We recommend limiting credit risk by favoring short-term over long-term corporate bonds, if appropriate for your circumstances.

We’re here for you

The coast may not be all clear headed into 2024, but it rarely — and perhaps never — is. That said, the recent broad-based rally has provided additional reasons to celebrate this holiday season. It’s a good reminder to stay invested according to your plan, even when the path appears uncertain. Talk with your financial advisor about the opportunities the market has created for your portfolio today, and consider adjustments that may help position you for the new year.

If you don’t have a financial advisor and would like help evaluating your portfolio, we invite you to meet with an Edward Jones financial advisor to discuss your goals and investment objectives, as well as our recommendations for 2024.

Strategic asset allocation guidance

Our long-term strategic asset allocation guidance represents our view of balanced diversification for the fixed-income and equity portions of a well-diversified portfolio, based on our outlook for the economy and markets over the next 30 years. The exact weightings (neutral weights) to each asset class will depend on the broad allocation to equity and fixed-income investments that most closely aligns with your comfort with risk and financial goals.

Diversification does not ensure a profit or protect against loss in a declining market.

 Strategic asset allocation guidance
Source: Edward Jones.

Opportunistic asset allocation guidance

Our opportunistic asset allocation guidance represents our timely investment advice based on current market conditions and our outlook over the next one to three years. We believe incorporating this guidance into a well-diversified portfolio may enhance your potential for greater returns without taking on unintentional risk.

 Opportunistic asset allocation guidance
Source: Edward Jones.

Tom Larm, CFA®, CFP®

Tom Larm is a Portfolio Strategist on the Investment Strategy team. He is responsible for developing advice and guidance related to portfolio construction, asset allocation and investment performance to help clients achieve their long-term financial goals.

Tom graduated magna cum laude from Missouri State University with a bachelor’s degree in finance. He earned his MBA from St. Louis University, is a CFA charterholder and holds the CFP professional designation. He is a member of the CFA Society of St. Louis.

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Important information

Past performance of the markets is not a guarantee of future results.

Investing in equities involves risk. The value of your shares will fluctuate, and you may lose principal. Small-cap stocks tend to be more volatile than large-company stocks. Special risks are involved in international and emerging-market investing, including those related to currency fluctuations and foreign political and economic events.

Diversification does not ensure a profit or protect against loss in a declining market.

Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity.