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Constructing Portfolios for the Fourth Quarter and Beyond: Equities (Part 1)

By:

Head of SPDR Americas Research

  • Low rates have encouraged risk taking, but equity returns have been supported by earnings growth
  • Growth is expected to slow and rates are expected to rise but remain low – creating challenges for investors
  • Focusing on small caps and quality stocks may help investors reposition portfolios

Global equities registered their seventh month in a row with gains in August, their longest stretch since 2018, and have now gone over 220 days without being in a 5% drawdown — the third-longest streak ever. In fact, the S&P 500® has notched 53 new all-time highs this year — the third-most of any year since 1991.1

Low rates, significant infusions of liquidity, and rebounding earnings have propelled these returns. As a result, investors have steadfastly favored equities relative to bonds. Equity ETFs have taken in $85 billion more than bond ETFs over the past three months, a figure that is in the 80th percentile and 158% above the typical three-month average.2

Yet, even with these returns and behavior, stocks are still cheap when compared to bonds3 — and that is likely to continue as the low rate environment has created a less than ideal future return scenario for bonds.4 Caution, however, has begun to creep into market sentiment. Three-month S&P® 500 put/call option skew as well as the put/call option interest ratio are elevated, with the latter sitting in the 92nd percentile over the last five years.5

Today’s complex environment has clients concerned with many variables that could alter the market’s trajectory: Policy normalization, tapering, low rates, fiscal spending impacts, inflationary pressures, expensive valuations, earnings growth stability, market gains concentrated around a few large stocks and the future path of an economy still dealing with the effects of the lingering COVID-19 pandemic. However, when grouped together, the through line of our client conversations centers on these two questions:

  1. How can I continue participating in a policy-supported rally marked by elevated valuations given concerns about the sustainability of future growth?
  2. Where can I source “real” levels of income within bond portfolios that can withstand rising rates?

In this first part of this two-part blog, I will address the first question related to equity portfolio positioning. Check out the second part on fixed income here.

Click here to read the full article

Footnotes

1. Bloomberg Finance, L.P. as of September 8, 2021
2. Bloomberg Finance, L.P. as of September 8, 2021, based on SPDR Americas Research calculations
3. Based on the Earnings Yield of the S&P 500 (3.71%) relative to the US 10 Year Yield (1.35%)
4. Bloomberg Finance, L.P. based on the 87% correlation between a current yield at time of purchase and the subsequent three-year return on the Bloomberg US Aggregate Bond Index per SPDR Research Calculations
5. Bloomberg Finance, L.P. as of September 8, 2021 based on the Put Call Open Interest Levels

Glossary

Bloomberg Barclays US Aggregate Bond Index
A broad-based flagship benchmark that measures the investment grade, US-dollar-denominated, fixed-rate taxable bond market.

CBOE VIX Index
The VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes.

Quality
Characterized by firms with strong balance sheets and high profitablity.

S&P 500 Index
A market-capitalization-weighted stock market index that measures the stock performance of the 500 largest publicly traded companies in the United States.

S&P High Yield Dividend Aristocrats Index
The S&P High Yield Dividend Aristocrats index is designed to measure the performance of the 50 highest dividend yielding S&P Composite 1500 constituents which have followed a managed dividends policy of consistently increasing dividends every year for at least 20 years.

Smart Beta
A term for rules-based investment strategies that don’t use conventional market-cap weightings.

Value
Characterized by lower price levels relative to fundamentals, such as earnings.

Volatility Skew
The difference in implied volatility (IV) between out-of-the-money options, at-the-money options, and in-the-money options. The volatility skew, which is affected by sentiment and the supply and demand relationship of particular options in the market, provides information on whether fund managers prefer to write calls or puts.

Originally Posted on September 17, 2021 – Constructing Portfolios for the Fourth Quarter and Beyond: Equities (Part 1)

Disclosures

The views expressed in this material are the views of the SPDR Research and Strategy team and are subject to change based on market and other conditions. It should not be considered a solicitation to buy or an offer to sell any security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. There is no representation or warranty as to the current accuracy of such information, nor liability for decisions based on such information. Past performance is no guarantee of future results.

This communication is not intended to be an investment recommendation or investment advice and should not be relied upon as such.

Unless otherwise noted, all data and statistical information were obtained from Bloomberg LP and SSGA as of September 8, 2021. Data in tables have been rounded to whole numbers, except for percentages, which have been rounded to the nearest tenth of a percent.

The research and analysis included in this document have been produced by SSGA for its own investment management activities and are made available here incidentally. Information obtained from external sources is believed to be reliable and is as of the date of publication but is subject to change. This information must not be used in any jurisdiction where prohibited by law and must not be used in a way that would be contrary to local law or legislation. No investment advice, tax advice, or legal advice is provided herein.

Investing involves risk including the risk of loss of principal.

Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.

Concentrated investments in a particular sector or industry tend to be more volatile than the overall market and increases risk that events negatively affecting such sectors or industries could reduce returns, potentially causing the value of the Fund’s shares to decrease.

The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
 

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