Q&A: Fixed-Income Investments and the State of the Market

It seems like the market returns this year were driven by stocks that benefited from the stay-at-home economy, and a comparatively larger swath of companies that stand to benefit from a broad economic recovery.

More sensitive “cyclical” companies felt the economic impacts of the virus and did not participate in the early recoveries. The financial sector, hit by low interest rates and falling loan demand; the energy sector, burdened by an oversupply in oil and falling demand for fossil fuels real estate, hurt by the glut of newly vacant office space; and the utility sector, pinched by a drop in industrial demand, were affected by the pandemic.

But there are positive signs: News of successful vaccine trials has offered a post-pandemic glimpse of a resurgence in bullish investor sentiment. The global market indexes have begun to reflect buyer interest in not only cyclical companies but also in smaller market-weighted companies. On the domestic front, the small-cap index, the Russell 2000, reversed to a September 2018 high, reflecting renewed confidence in smaller and more economically-sensitive companies.

In this age of information overload, great upheaval and profound uncertainty, financial advisors and investors find themselves returning to the same question: How best to invest in such seemingly unprecedented times? To help get a grip on the economy, stock market and future of investing, we spoke with Tom Stringfellow, president and chief investment officer at Frost Investment Advisors.

He shares his thoughts on the future and what advisors and investors can do to navigate this ever-more unpredictable world. Here are edited excerpts from that interview.

[See: The Best Podcasts for Financial Advisors]

How do you advise clients who are looking for income and safety in this ultra-low yield environment?

Bonds have become a difficult investment choice for savers given their low yield and limited upside. At today’s interest rates of generally less than 1% for shorter maturities, the real return after inflation is usually in negative territory. At these rate levels, we do not dismiss the need for fixed income as they usually still provide investors and savers with a level of liquidity, stability, predictability and diversification.

Fixed-income instruments should also provide some diversification against any further volatility in the equity markets in addition to a source of liquidity for income needs. The important consideration for investors and savers, however, is to focus on quality, shorter maturities and where possible, active management to help navigate around future interest shifts.

For investors in need of a higher income stream, one suggestion is to consider a diversified portfolio of both fixed-income and dividend-paying stocks: The former providing a source of liquidity and diversification with the latter providing a higher income stream and the potential for appreciation. The risk of course is always the potential for unexpected market swings.

[READ: Q&A on How Financial Firms Should Adapt Technology Post-Pandemic.]

What signals do we tend to look at today to tell us about the market’s current and future health?

Markets are a forward-looking barometer of the future economic environment. While the environment was surreal in late spring with the pandemic shutdown, we began to see financial markets starting to revive from their rapid decline. By late March the daily headlines were counting COVID-19 caseloads and economic shutdowns. Financial markets, however, were beginning to trade beyond near-term fears of the lockdown as investors bought into expectations over the longer-term.

Understanding that the markets reflect tomorrow’s expectations helps explain why markets rally (or fall) despite today’s economic news. Investors continually forecast earnings, interest rates and confidence levels, looking outwards toward the next several quarters. This is also the case with corporate earnings, manufacturing outlooks and housing expectations. In March, investors were trying to gauge the economic environment not at the bottom of the markets but rather well into 2021.

[Read: Liz Ann Sonders — Stock Market Outlook for Q4 and 2021.]

The early indicators that caught investor attention included a number of indicators from the economy, the central banks and the U.S. government. Early government relief packages, enhanced unemployment benefits and lower interest rates from the Federal Reserve provided needed assurances to investors and the markets. With market stabilization and liquidity assurances, investors began looking toward the future.

In short order there were reports of improving retail sales from the pandemic lows. Despite semiquarantined households, the housing markets took off as buyers began looking for new places to move. Countries first falling to the virus began to open up, which led to the early stages of reopening here at home. These signals were all adding up to what investors believed would be a recovery in the economy over the next few quarters.

Today, the picture is roughly the same, despite an uptick in caseloads. Consumer optimism is recovering and the vaccine is hopefully only a few months away. Manufacturing is beginning to open back up as inventory levels are at near lows and the unemployment level continues to slowly improve. And while the recent virus spikes are concerning, the markets are quite a bit more optimistic than what we read in the headlines today.

More from U.S. News

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Q&A: Fixed-Income Investments and the State of the Market originally appeared on usnews.com

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