A pleasantly surprising rally, skillfully led by a select group of tech giants known as the 'Magnificent 7,' has prompted us to moderate our overweight position in the tech sector. These companies benefited greatly from the AI boom, driving their outperformance. However, we anticipate a slowdown in risk assets during Q3, with returns diversifying to include year-to-date underperformers, such as midcaps.
Despite these positive developments, we should remain cautious. While the worst uncertainties arising from bank failures seem to have abated, and lending cuts appear less severe, stock markets have been artificially supported by one-time injections of liquidity from the Federal Reserve's emergency bank lending program and the drawdown of the US Treasury's General Account balance. As these injections are now being reversed, commercial bank reserves at the Fed are decreasing, potentially causing market indigestion later in Q3. Consequently, we have reduced exposure to liquidity-sensitive assets like emerging market stocks and lower-quality credit.
Although the likelihood of a recession has decreased compared to four months ago, we observe the persistent influence of 'revenge spending' by consumers, fueled by pent-up demand and excess savings after the pandemic. However, this economic resilience may complicate the battle against inflation, which has dropped from 9% to 3% over the past 12 months. The Fed is determined to continue its rate-hiking and quantitative tightening measures, causing Treasury markets to adjust accordingly, perhaps even overshooting.
Taking advantage of this surge, we have added yield through floating rate Treasuries and TIPS, which offer higher-than-normal real yields. Additionally, we have supplemented this strategy with long-term Treasuries, adopting a barbell approach to protect against potential excessive Fed tightening against an already weakened economic backdrop. This is essential to avoid the realization of what many have been dreading for the last 18 months - recession.
In summary, our investment approach acknowledges the elevated uncertainty and potential downside risks in the current environment. By adjusting our portfolio to reflect these conditions, we seek to navigate the evolving market landscape and position ourselves for long-term success.
Please call us at 518-885-3230 or 239-435-0090 to let us know if you have questions. We welcome clients who are interested in financial planning, opening investment accounts, or adding to existing investment accounts.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Tax Advisor
Tina Alteri, CPA, Tax Advisor
