Model Updates

Shifting the Stock-Bond Mix in Favor of Stocks

Based on improved return expectations for U.S. stocks and modestly lower return expectations for flexible bond funds, we are adding an increment back to stocks funded from these bonds.

Over the past few months, The Gardner Group reevaluated the assumptions behind our five-year U.S. stock return estimates across varied economic scenarios. We now believe a five-year annual return for U.S. stocks in the mid- to upper-single digits is the most likely outcome, with a reasonable chance returns will be higher (an upside scenario plays out). Beyond the improved five-year return outlook for U.S. stocks, we also place weight on the shorter-term (12-month-plus) macroeconomic and policy backdrop, which we view as supportive of stock returns. Over the past few quarters, the light at the end of the COVID-19 tunnel has brightened thanks to widespread vaccinations and other public health responses to the pandemic.

With the upside scenario for stocks more likely in our view, the relative attractiveness of flexible bond strategies is reduced. And while we recognize the risks are not equivalent, flexible bond strategies will often invest in below-investment-grade bonds, which can exhibit “equity-like” risk. Thus, it is valid to compare flexible bond strategies and stocks. In our view, that comparison warrants shifting the balance modestly toward stocks.

This trade increases our balanced portfolios’ overall expected return while also increasing the equity risk exposure incrementally. U.S. stocks are not cheap on an absolute basis. But with a supportive economic and corporate earnings backdrop, we see room for additional gains with a low likelihood of a recessionary bear market on the horizon. Low bond yields also provide relatively weak competition to stocks. In other words, the relative valuation of stocks versus bonds is reasonable as long as interest rates don’t move sharply higher. A rising-interest-rate scenario is possible, but it’s not our base case.

The current macro backdrop should also be supportive of the below-investment-grade bonds our actively managed flexible bond managers may invest in. But given the still very low absolute yield levels and historically tight credit spreads, we believe stocks are now, at the margin, more attractive from a risk/return perspective. Therefore, in these trades we are reducing equity-like risk on the bond side and allocating an additional increment to equity risk on the stock side.

Unwinding Our Tactical Treasury Position Within Core Bonds

On the fixed-income side of your portfolio, we are shifting back into active core bond funds from bond funds with heavier exposure to US Treasuries. This decision is driven by two main factors:

1. Our active core bond managers’ potential to add significant excess return over both Treasuries and the core bond market index
2. Our view that recession risk (when Treasuries would perform most strongly) is very low

More broadly, our tactical view on core bonds as an asset class has not changed: Our five-year return expectations remain very low, but the asset class still plays an important strategic (long-term) risk-management role. As a result, we remain underweight to core bonds—at around half their strategic allocation—in favor of tactical positions in flexible actively managed bond strategies and floating-rate loan strategies that, in our view, have significantly better return prospects without undue risk.

As always, The Gardner Group appreciates the trust you place in us as stewards of your capital. If you have any questions about these allocation changes or your specific financial plan, don’t hesitate to reach out to us.