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Aug. 13, 2022, 3:21 p.m. EDT

Inflation surge cools in July. Should you still play defense with your portfolio?

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By Frances Yue

Investors hopeful about a potential retreat in U.S. inflation from its highest levels in decades have been piling into stocks, even as several high-profile investors warn the rally may be a mirage. 

The latest surge in stocks helped lift the Nasdaq Composite /zigman2/quotes/210598365/realtime COMP +3.34% out of bear-market territory on Wednesday and the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +2.80% to exit correction territory. But the sharp upswing also prompted debate about if investors should adjust their portfolios, pivoting away from defense plays.

For the past month, growth stocks in general outperformed their value counterparts. The Russell 1000 Growth Index /zigman2/quotes/210598136/delayed RLG +3.23% advanced 13%, while the Russell 1000 Value Index /zigman2/quotes/210598148/delayed RLV +3.19% gained 9.5%, according to Dow Jones Market data. Cathie Wood’s tech-heavy ARK Innovation ETF /zigman2/quotes/204808965/composite ARKK +7.63% rose 10% in the past month, topping the 8.3% gain of Warren Buffett’s Berkshire Hathaway /zigman2/quotes/200060694/composite BRK.B +2.82% shares for the same period.

Liz Young, head of investment strategy at SoFi, said investors should consider being in the market and out of cash by the end of summer, though she remains skeptical of the quick rise of stocks since mid-June. “In the case of the Fed’s current goal, markets are starting to believe in the possibility of a soft landing,” Young wrote in a Thursday note. 

However, that’s not what the bond market has been signaling, said Nancy Davis, portfolio manager of the Quadratic Interest Rate Volatility and Inflation Hedge Exchange-Traded Fund /zigman2/quotes/212340916/composite IVOL +0.49% . The yield of 2-year Treasury /zigman2/quotes/211347045/realtime BX:TMUBMUSD02Y -0.11% note remains higher than that of the 10-year treasury bond. /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -0.16% “It’s a substantial inversion,” Davis noted. “It’s really the market pricing the low- growth kind of bad scenario.” 

Helping to fuel risk appetite, the U.S. consumer-price index was unchanged in July , the Labor Department said Wednesday, compared with the 1.3% gain in the prior month. Economists polled by The Wall Street Journal had estimated a 0.2% advance in July.

A day later, the U.S. producer-price index fell 0.5% in July, the first negative monthly print since April 2020. That’s compared with a 1% jump in June. Economists polled by The Wall Street Journal had forecast a 0.2% advance.

A diversified portfolio? 

Mark Heppenstall, president and chief investment officer at Penn Mutual Asset Management, said that as long as inflation continues to trend lower, the classic 60/40 portfolio, with 60% invested in stocks and 40% in bonds, will continue to provide reasonable returns. 

“In most market environments, it’s helpful to have broad and balanced exposure,” said Brian Storey, senior portfolio manager at Brinker Capital Investments. 

Storey suggested that investors consider adding high-quality stocks to their portfolio. For investors with a risk posture that’s a little more conservative, Storey encourages them to look outside of equity markets. “Some investment-grade fixed-income corporate bonds, or even some noncore fixed-income, like high-yield bonds, bank loans or emerging-market debt — those are areas [where] spreads widened a lot,” Storey said.

“Given that there doesn’t seem to be any extreme areas of stress in financial markets over the next six-to-12 months, those are areas that should see some fairly attractive returns, particularly compared to US Treasurys,” Storey said.

Growth vs. Value Stocks 

Still, Storey has been skeptical about whether the recent rally led by growth stocks is sustainable, given that it has been partly driven by the fall in the 10-year treasury yield. 

The 10-year Treasury /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y -0.16% advanced modestly for the week to 2.848% on Friday, still below its 3.482% high in June.

“I think now that we’re gonna see treasury yields a little bit more range bound,” said Storey. “So I think that the decline in yields that has been a catalyst for those Nasdaq stocks is probably not going to be as much of a tailwind in the future.” 

Even if the stock rally continues, “I don’t think that people are going to be going back to the same kind of leadership names,” said Stephen Hoedt, managing director at equity and fixed income research at Key Private Bank. While the rally since June has been led by some “unprofitable technology companies,” the market is likely to gravitate for leadership of high quality growth companies, such as some in healthcare and consumer discretionary, Hoedt noted. 

“You just can’t put money to work in technology willy-nilly right now. Because there still are significant valuation concerns,” Hoedt said. “And the fact that we’re in a higher interest rate environment is a headwind for companies that do not have earnings or have more difficult profitability than others.”

More rate hikes

Next week, investors will be focused on initial jobless claims data and existing home sales number. 

Later this month, the Fed will hold its Jackson Hole Economic Symposium, which could be the next major catalyst for market movements, analysts said.

“There are a lot of hawkish expectations from the forward guidance,” Quadratic’s Davis said. While the Fed has raised interest rates by 225 basis points already this year, the market is pricing in an additional 117 basis points of hikes to come for the rest of the year, Davis noted.

She will be tuned into the Jackson Hole summit for any talk about how the Fed officials plan to use the central bank’s balance sheet as a monetary policy tool to fight inflation.

For the past week, the Dow added 2.9% to around 33,761.05. The S&P 500 /zigman2/quotes/210599714/realtime SPX +3.06% gained 3.3% to 4,280.15, and the Nasdaq rose 3.1% to 13,047.19.

Hear from Carl Icahn at the Best New Ideas in Money Festival on Sept. 21 and Sept. 22 in New York. The legendary trader will reveal his view on this year’s wild market ride.

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US : FTSE Russell
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US : S&P US
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