Portfolio Management Update

My view is the economy is in a mid-cycle phase. A mid-cycle economy is characterized by rising corporate profits, increasing credit demand, moderating cost pressures and a change over to a neutral monetary policy. Historically speaking, mid-cycle periods have provided a favorable backdrop for equities, generating returns averaging 14% a year based on a Capital Group analysis of economic cycles and returns dating back to 1973.

Given it is the third year of this bull market where the first two years of gains were 20% plus each, and monetary policy could shift to neutral, a balanced strategy, investing in both stocks and bonds makes sense to me. Bonds offer the highest current income in years, and stocks still offer potential appreciation in response to projected acceleration in earnings growth. Also, a balanced strategy would dampen portfolio drawdowns that are likely to come in any year. Last year, the stock market did not have a correction. It may happen this year if the 10 Year Treasury yield breaks out above 5%.

Intermediate to short-term bonds are a diversifier against equities now as bond yields have normalized. Thereby offering some protection in a market correction. What is more, current bond market yields are historically attractive enough to compete directly with stock returns on a risk-adjusted basis. Investors are more likely to rebalance into bonds now than under a zero-interest rate policy experienced a few years ago. Historically, monetary easing and a pause in cuts not followed by a hike in rates have been a positive interest rate environment for both bonds and stocks.

Within equities, I am investing in Large-cap Growth stocks that benefit from AI tailwind as well as more cyclical areas of the markets like Mid-cap stocks. Within bonds, I think an allocation to short-intermediate duration fixed income investments versus long duration bonds is the best approach to managing bond market risks. This investment allocation may provide more growth and income in a mid-cycle economic scenario.

The yield curve is positive for the first time in years, suggesting the economy could accelerate, which also favors the cyclical sectors over defensive ones. Current equity sector price performance suggests cyclicals would be the better long-term investment than defensive stocks. Sectors showing better sales growth are Information Technology, Health Care, and Communication Services.

The growth-stock investment theme that led the market last year may continue to perform well this year. Presently, a higher cost of capital environment favors companies with higher quality earnings and balance sheets and larger companies that are less vulnerable to high interest expenses. Quality companies with better returns on equity. Moreover, spending on artificial intelligence capabilities, and the build-out of data centers continues to drive earnings growth expectations for the quality growth stocks. It is early days for AI, there are only rough estimates on how large the potential market will be. PricewaterhouseCoopers estimates it could be $15.7 trillion by 2030. Technology stock valuations have shrunk but still are trading at a premium because their sales growth, earnings growth and profit margins are superior to other stocks. Top Tech analyst, Dan Ives of Wedbush Securities says AI evolution is in its early days with a present universe of spending estimated at $2 trillion. He sees it expanding into robotics, auto driving and so on. It is too early to call a peak in earnings for stocks benefiting from AI related sales.

The most attractive area of the US stock market is Mid-cap stocks trading at a more reasonable valuation and higher estimated earnings growth. Midcaps are less sensitive to interest rates than Small caps which makes them more defensive than Small caps. Moreover, Midcaps trade at a discount to MAG 7 stocks and Large-cap stocks. If the market broadens out in 2025, Midcaps which have lagged Large caps could experience a period of outperformance over MAG 7 and Large caps. If AI spending should moderate, it is currently not projected to moderate, then MAG 7 stocks would lag, and Midcaps could be the recipient of cash inflows from MAG 7. Altogether it is a good hedge if the economy continues to expand and a rotation out of MAG 7 does occur sometime this year.

What else am I investing in and why?

The Healthcare sector is trading at attractive valuations compared to the S&P 500 Index and sectors that have outperformed. While health care lagged in 2024, low current valuations could provide an opportunity for investors who want exposure to a sector with strong long-term drivers—chief among them an aging U.S. population increasingly in need of medical care. The sector also sports improving business fundamentals, like cash flow. The Health Care sector is the third cheapest investment sector, making it a contrarian buy. It is expected to see the largest price increase between current prices and year-end.

The Financials sector is predicted to report the highest year-over-year earnings growth rate of all eleven sectors for the fourth quarter at 39.5%. Bank earnings season has begun, and the results are beating expectations. Net Interest margin income, loan and deposit growth are positive contributors to profits. A steeper yield curve, and industry anticipation of a more favorable regulatory environment than has existed in a decade. Higher profits, lower reserve requirements, lower compliance expenses, allow the Banks to increase dividend payouts, buy back stock, and reinvest in their business to grow sales. Lastly, Financial sector is the second cheapest sector to invest in.

I also like the Energy sector due to de-regulation expectations and the ever-increasing demand for energy. President Trump has signed a series of executive orders aimed at increasing domestic energy production. Additionally, Trump's policies are focused on energy infrastructure projects, many AI related, which could lead to increased investment opportunities in the energy sector. Increasing energy supply should go a long way to lowering energy prices. The energy sector happens to be the cheapest sector among all sectors based on the latest FactSet report. Its forward Price/Earnings is 13.8 versus the S&P 500 of 21.5. Energy stocks have a low hurdle to beat forward earnings estimates and have the highest amount of buy ratings among the eleven investment sectors. Wall Street Analyst see about an 18% increase in price appreciation in 2025 given estimates pan out.

What are my thoughts on investing abroad?

When the U.S. dollar is strong, like now, foreign equities can be less attractive to U.S. investors because the returns on these investments are worth less when converted back to dollars. This can lead to lower demand for foreign stocks and potentially lower prices. A stronger U.S. dollar tends to be better for U.S. equities, especially for companies that import goods. This can lead to higher profit margins and potentially higher stock prices. On the other hand, non-U.S. still looks attractive valuations. The trailing one-year price-to-earnings (PE) ratio for U.S. stocks remained well above its long-term average. Whereas foreign Developed market and Emerging markets trailing valuations are lower, and for the most part because most world economies are not as fundamentally attractive as the USA. The US economy has the best fundamentals for earnings growth. The US economy is in better shape, has significant capital inflows, is the world-leading technology industry, and is energy independent. I am underweight foreign securities compared to US equities in all portfolio strategies.

Aspetuck owns Gold versus Crypto to hedge against Government deficit spending and excessive borrowing. US Government tax receipts are at record levels – it is a spending problem and how tax revenue is spent. I view crypto as a “risk on” asset and gold as a better portfolio diversifier in times of inflation and crisis. It is a geopolitical hedge. Many foreign governments are building up reserves to hedge against devaluation of currency and geopolitical risk creating support for gold prices.

What are the current adjustments to the bond’s component of portfolios?

The recent jobs report shows strong labor, suggesting the economy does not need to be bailed out by deeper rate cuts. I have trimmed exposure to long-term credit bonds and reinvesting in Intermediate Term Credit Bonds. Why? No recession, instead the economy is in an expansion, investors do not need recession protection of Long-Term Bonds. Moreover, the bond market has discounted expected rate cuts, therefore long-term bond prices are fully priced. Lastly, for the following reasons long term bond prices may decline this year because the US Government’s deficit spending funded by issuance of Government bonds requires greater supply of bonds than meets demand. Bond investors will require lower prices and higher yields to buy US Treasury bonds. Furthermore, the Trump administration policies may be inflationary, which would cause inflation sensitive long term bond prices to decline.

The US Government continues to spend and borrow beyond its means – Government debt is now a whopping $36 trillion! The Government expects to issue $12 trillion in Treasury issuance in 2025! Bond investors may want a higher yield from Treasuries to induce them to buy, especially if Government debt levels reach a level that warrants a credit downgrade.

Yields on cash and shorter maturity may not decline much further at this stage. Therefore, I’ve re-positioned bond exposure to short to intermediate bonds and increased floating rate notes in credits. The long end of the yield curve has become the riskiest part once again. The sweet spot of the yield curve is the middle of the curve, three to five years in maturity. The short to middle manages interest rate risk, reinvestment risk, and purchasing power risk better than either the short end or the long end.

I have added to Non-investment grade bonds, leveraged loans, as the economy remains strong default rates are low. Yields are also higher than investment grade bonds. Credit spreads reflect a benign economic outlook, but investors can still benefit from the higher yields offered by corporate investment-grade and high-yield bonds compared to Treasuries.

I am positive once again about cash equivalents. Cash yields are likely to remain attractive compared to intermediate and long term bonds. Interest rates are stickier because of sticky inflation. In addition to an ETF investing in inflation-indexed Treasury Bills, cash equivalents are in investment-grade floating rate notes with minimal interest rate risk due to a duration of 0.02.

ASPETUCK is a (SEC) registered investment adviser. The information presented is for educational purposes only intended for a general audience. The information does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and are not guaranteed. ASPETUCK has a reasonable belief that this marketing does not include any false or misleading statements or omissions of facts regarding services, investment, or client experience. ASPETUCK has a reasonable belief that the content as a whole will not cause an untrue or misleading implication regarding the adviser’s services, investments, or client experiences.

ASPETUCK has presented information in a fair and balanced manner.
ASPETUCK is not giving tax, legal or accounting advice, consulting a professional tax or legal representative if needed.

Past results are not predictive of results in future periods. While money market funds seek to maintain a net asset value of $1 per share, they are not guaranteed by the U.S. Federal government or any government agency. You could lose money by investing in money market funds. The market indexes are unmanaged and, therefore, have no expenses. Investors cannot invest directly in an index. The S&P 500 Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks. The S&P 500 is a product of S&P Dow Jones Indices.