Question of the Week.

A hawkish Federal Reserve, the relentless rise in bond yields, and a liquidity crunch in China have made it a great deal tougher for some investors to stay invested in anything other than cash at the moment, but we think it will pay off to remain exposed to equities. In terms of the Fed, while it is likely they may begin tapering their current asst purchases as early as September, the pace at which they remove stimulus will likely be a great deal slower than the markets have currently priced in. At the same time, the other major central banks, including the Bank of Japan and the European Central Bank, are likely to add to rather than slow their stimulus efforts. The recent rise in the Yen probably forces the Bank of Japan to step it up, especially if they hope to meet their goal of taking inflation up to 2%. The markets also appears too pessimistic about the timing of interest rate hikes in the U.S. since the recent increase in bond yields have already pushed up mortgage rates since early May. This move in mortgage rates is its own form of monetary tightening on the economy. We don’t expect mortgage rates yields rising.

The recent shock to stock markets from concerns about pending Fed tapering has caused P/E ratios to contract as well. We think improved equity valuations—especially when compared to valuations in fixed income and the return opportunities of being invested in cash (nil)—make stocks the most attractive of the asset classes. We note that U.S. equities have marginally outperformed bonds and corporate credit since the sell-off started in late May and are the best performing asset class year-to-date. Despite the rally though, the asset class remains under owned. Since May, $13 billion has come out of global equity funds. We believe that when the markets calm from their immediate reaction to the Fed, the cash holdings recently raised will be redeployed into stocks and likely into U.S. stocks. We remain overweight on stocks within a multi-asset portfolio but security selection has become increasingly important. We remain underweight on bonds and neutral on cash. We are underweight on commodities, but we expect them to eventually have a bounce once global growth becomes self-sustaining.