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3 Topics for Year-End Client Talks — Searching for Alpha for December 2016

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The last time I wrote about inflation was August 2011. Since then, rising prices was seen as a high-class problem that would return only if the economy and the equity markets ended their addiction to lower rates.

That looks to be the case now. While long-term bonds sold off more than 8% last month, stocks managed an impressive post-election rally. There are scads of reasons to explain the end of the years-long relationship between lower rates and higher stock prices, with the ones most often cited being the potential for increased fiscal spending and lower corporate tax rates.

This new inflection point not only means that portfolios need a re-think, it also marks some important talking points for clients as we approach year-end. 

The potential list of topics includes the following: 

  1. Fixed Income Sizing 
    With rates very likely going up in December, bond holdings need a closer look. Favoring corporate paper over Treasuries makes a lot of sense, since a growing economy lessens the chance of bankruptcy. 
    High-yield and convertible securities have the least interest-rate sensitivity and deserve a spot in most portfolios.
  2. Steeper Curve
    Higher rates will lead to a steeper yield curve (i.e., long-term rates higher than short-term rates). That’s great for banking stocks – the KBW Bank index has risen about 14% since the election – and there will likely be an increased merger activity in the space. 
    Consider an outsized large-cap value position to capture the move.
  3. Choosing an Inflation Hedge
    Historically, stocks have proven to be an excellent hedge against inflation (although runaway price increases are typically not good for equities). Gold, however, has a dubious track record as a hedge.
    Other solid hedges include commodities and emerging markets.

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