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Q3 2020 Portfolio Management

Q3 2020 Portfolio Management

Bond Returns Likely to Underperform Dividend Paying Stocks

Economic indicators continue to improve, and vaccines are on the way. I am favoring equities over bonds because I think the economy is no longer in recession but has moved into its expansion phase. Stock and bond prices are at lofty levels and present risks, but I think the trade is still TINA (There Is No Alternative) to stocks, given monetary stimulus.

Bond yields are near decade lows and prices at decade highs. That means it is easier to quickly lose money in bonds. A drop in your bond’s price could offset your annual yield in one trading session. I would rather take risk with quality dividend paying stocks than bonds. During ultra-low interest rate and lean market periods, stock dividends played a key role in an investment’s total return. Given my view that yields will rise over the next twelve months, bonds returns are likely to underperform dividend paying stock returns. Furthermore, sideways market favor dividend paying stocks, floating rate notes, preferred stocks paying dividends.

The Yield curve is steepening. Steepening yield curve suggest rebalancing from defensive large-cap stocks to economically sensitive Small-cap stocks. I have been increasing account exposure to small-caps, which have been outperforming large-cap stocks over the last thirty days. Positive news flow regarding effective vaccines would also support small-cap outperformance.

My equity strategy is to own a barbell of new economy Tech/COVID stocks (higher sales growth) on one end and the other end dividend paying economically sensitive ones (cheap valuations). I think long term the new economy stocks have room to run much higher, but economically sensitive stocks could outperform higher valuation stocks as economy accelerates.

I am still favoring U.S. stocks over foreign investments. However, I am increasing Emerging Market equity as I am bearish on U.S. dollar and bullish in emerging market economic growth. Emerging market economies are recovering faster from COVID.

Expectations for rising inflation favor investing in small caps, bank, energy and industrial stocks, gold, short-duration corporate credit, TIPS, leveraged loans and convertibles. With that said I am overweight stocks hedging equity risks by owning Gold, Inflation Protected Treasuries, and inflation protected short-term bonds. I have added more exposure to Industrials and slightly trimmed Technology exposure, though am still overweight. The proceeds from sale of Technology stocks was invested in economically sensitive cyclical stocks, recovery theme stocks that should perform well as economy opens. Most of these stocks pay dividends.

If the Fed can generate higher inflation using all its stimulus programs, long term Treasuries are most vulnerable to big prices declines. To protect accounts from interest rate risk, the bond component carries a short to intermediate bond maturity.

I am investing in cash in inflation adjusted Treasury Bills/Notes as cash-equivalents investments The investment I use for cash-equivalents has a higher yield than long-term Treasuries, has no interest rate risk, has the highest credit rating, and will preserve capital in a correction.
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