The Federal Reserve cut the target for the Federal Funds Rate by 50 basis points on Wednesday to a range of 4.75% to 5.00%. A slight majority of Fed officials also favored additional 25-basis-point cuts in November and December. With the Fed signaling that rates will be coming down for months and its first cut coming later than expected, many financial advisors adjusted their portfolio allocations months ago.
However, with the downward move finally taking place, WealthManagement.com connected with some advisors to find out if they were taking additional measures or making new recommendations to clients. Some common themes among their strategies have so far included increased exposure to equities and longer-term bonds.
According to Gary Quinzel, vice president of portfolio consulting at Minneapolis-based Wealth Enhancement Group, an RIA with more than $85 billion in AUM, the cut and direction on future cuts were in line with expectations.
Wealth Enhancement Group had already adjusted its fixed-income allocations in anticipation of the new rate environment.
“We have long employed a barbell strategy for Treasuries. We have now moved away from the short end and are looking to maintain duration,” Quinzel said. “With investment-grade credit, there are a lot of flows and some opportunities there. We like duration. We like seeing opportunities on the steeper end of the yield curve. We had spent some time looking at leveraged loans several months ago, and those are based on floating rates, and that’s not an area that’s as interesting anymore.”
Quinzel added that the rate cut should also be positive for equities.
“The market will bounce around a bit as we dissect the components of what Powell is saying, but we are fairly optimistic on equities,” he said. “We continue to like U.S. equities and high-quality. We have been shading away from growth to focus more on the S&P 493, as you might say. At the same time, we are maintaining our overall exposure to U.S. growth stocks.”
Even before the Fed’s rate cut, intermediate-term rates like the one on the five-year Treasury fell by more than 100 basis points compared to where they were this spring, wrote Neil Gilfedder, CIO at Edelman Financial Engines, an RIA with $288 billion in AUM. “The markets are constantly pricing in new economic data, not waiting for Fed decisions,” he noted.
For medium- and long-term investors, Edelman Financial Engines has a broad range of fixed-income assets, diversifying them by issuer and maturity schedule. Otherwise, the firm has avoided making short-term changes to its overall portfolio allocations since the timing of subsequent interest rate cuts is not set in stone despite the Fed’s most recent comments, according to Gilfedder.
However, he added that Edelman Financial Engines is advising clients who previously put money into money market funds with attractive rates to consider redeploying that cash. “With the Fed poised to continue to lower rates, being out of the market means missing out on those capital appreciation opportunities. That’s why we always advise our clients to work with us to create a plan and then stick to it,” he wrote.
Barry Gilbert, portfolio manager at Omaha, Neb.-based RIA Carson Group, with $37 billion in AUM, noted the importance of longer-duration bonds.
“Markets tend to be forward-looking, and we have traded around anticipated cuts over the course of the year by increasing the interest rate sensitivity of our bond portfolios,” Gilbert wrote in an email. The firm added some exposure to long-term Treasuries last November and is keeping short-term bond positions at a minimum. “The anticipated shift toward rate cuts also supported our continued stock overweight.”
In an investor note, Jeff Buchbinder, chief equity strategist with LPL Financial, looked at how stocks have historically performed after initial rate cuts.
"On average, value stocks slightly outperformed their growth counterparts three and six months after the initial cut, but growth outperformed 12 months later," Buchbinder wrote. "The 1995 cycle seems most analogous to where we are currently. During the 12 months after that cut, growth was slightly better, but value had an edge over the first six months."
Buchbinder also found that defensive sectors tend to outperform in the early months after a cut.
"This was particularly evident during the comparable 1995 period that included a soft landing and technology buildout," he wrote. "Healthcare and the defensive telecom services sector (before digital media was added in the sector’s revamp) were top performers, while consumer staples and utilities also outperformed. (LPL Research upgraded healthcare to neutral this month, is neutral consumer staples, and recommends overweighting communication services.)"
In a response to a request for comment from WealthManagement.com, Buchbinder added, "We at LPL Research continue to recommend investors stay fully invested in equities at their target levels while being watchful for higher volatility ahead of the upcoming election. The Fed news doesn’t change that. he larger cut does make us more comfortable allocating to defensive sectors such as consumer staples, healthcare, and utilities, which have historically performed well after the Fed starts cutting. Rate-sensitive small caps could get a boost from Fed rate cuts, but even with a less restrictive Fed, it might not be lasting as the economy is poised to slow."
John Lynch, chief investment officer for Comerica Wealth Management, which has $2.4 billion in AUM, added, "We look for traditional beneficiaries, including small caps, value, cyclical sectors and the equally-weighted S&P 500 Index, to experience tailwinds."
RFG Advisory, a Birmingham, Ala.-based RIA with $5.4 billion in AUM, has also been recommending that clients add duration to their fixed-income portfolios for several months, according to Rick Wedell, president and CIO. He noted that some longer-duration securities should offer clients extra protection if the economy’s landing is not as soft as expected.
“The single biggest issue that rate cuts will have on portfolios is actually the macro effect,” Wedell wrote. “Is the Fed far enough ahead of the curve to be able to get back down to 3.0% or 3.5% on Fed funds before unemployment creeps up too high?
"On balance, we may see some shift of short-term fixed income into longer-term since the rate cut is now ‘official.’" he added. “The reality is that most of those types of moves should have already been priced in, given the widely anticipated nature of these cuts. Longer term, the Fed signaled 100 basis points of easing this year and another 100 next year, which means we won’t be back to a 'neutral’ rate for quite some time. That means that short-term yields may stay above longer-term Treasuries for the next 12 months or so. So the movement from short term into long term may be gradual."
Philip W. Malakoff, executive managing director and director of research with First Long Island Investors LLC, a Jericho, N.Y.-based wealth management firm with approximately $2 billion in assets, said the firm began increasing duration in its fixed-income portfolio about a year ago based on anticipated interest rate cuts, focusing on bonds with 10-year maturities. Since lower rates tend to favor equities, First Long Island Investors has also slightly increased its equity exposure and rebalanced some client portfolios, moving money from large cap into small-cap stocks and other types of equities.
Malakoff added that right now might be a good time to invest in some value stocks. “Value stocks, particularly dividend-paying and dividend-growing companies, tend to do better in a lower interest rate environment, as they attract money being reallocated out of fixed income.” He cited real estate holdings, including REITs, as assets likely to benefit from lower borrowing costs.
This is a developing story that will be updated as more comments roll in from advisors.
