Monthly portfolio brief

Positioning portfolios for interest rate cuts

What you need to know

• The Federal Reserve and the People’s Bank of China recently eased policies to reduce economic growth restraints, sending markets higher.
• Cyclical and more interest-rate sensitive segments of the market generally outperformed in September, sparked by lower rates and economic optimism.
• With multiple major central banks cutting rates, consider revisiting the purpose of your cash allocations and reducing overweight positions. Also consider overweighting interest-rate risk within investment-grade bond allocations.
• As monetary policies become increasingly supportive for economic growth and market leadership broadens, consider overweighting equity over fixed income, favouring U.S. stocks.
• Within international equity, we've recently raised our recommended target for emerging-market stocks and lowered developed-overseas stocks.

Portfolio tip

Revisit the purpose of the cash in your portfolio. You want enough to support your overall financial strategies but not so much that it limits the return needed to make progress toward your long-term financial goals.

Where have we been?

Central banks eased policies to reduce economic growth restraints. September started with a short period of volatility, rhyming with the start of August. The market displayed concerns that softer labour markets were creating risks for economic growth. But with inflation trending toward central bank targets, multiple major central banks, led by the Bank of Canada, have reduced interest rates in recent months so that monetary policy doesn’t restrict economic growth for too long.

The Federal Reserve joined the rate-cutting cycle in September by cutting the federal funds rate by a relatively sizable 50 basis points. The People’s Bank of China also announced a package of stimulus measures, such as interest rate cuts and housing support, to help prop up China’s weakened economy.

Markets rallied in response, with more economically sensitive and interest-rate sensitive investments generally outperforming. Sparks of economic optimism — and the expectation that similar policy adjustments will continue — propelled markets. By month-end, all asset classes finished with positive returns, although equities generally outperformed fixed income.

Canadian and emerging-market equities, which have lagged U.S. large-cap stocks for much of this year, outperformed in September. Canadian equities were supported by strength within more cyclical and interest-rate sensitive sectors, including financials and materials – heavyweights within the domestic market.

Emerging-market equity, specifically, claimed the top spot. The steps taken by China’s policymakers to boost the property market and overall growth sent Chinese stocks, and emerging-market equity more broadly, sharply higher.

Bonds also performed well in September, supported by trends of lower interest rates, moderating inflation and softening growth. Lower-quality bonds, which tend to be more economically sensitive, slightly outperformed higher-quality bonds. These bonds benefited from their higher yields and contained credit spreads amid supportive economic trends overall.

Cash-like investments lagged, resulting in a drag on portfolio returns relative to other asset classes. When compared to longer-term historical trends, 12-month returns within the cash asset class have been strong. In previous years, cash yields have become increasingly attractive during central bank rate-hiking cycles. But cash has significantly underperformed other asset classes in more recent periods, despite today's higher yields, weighing on portfolios with overweight cash positions. This underperformance highlights cash allocations are not risk-free.

What do we recommend going forward?

Revisit your allocations to cash-like investments. Cash allocations can help you manage ongoing expenses, pay for unexpected expenses, save for a short-term financial goal, or be a source of investment for a long-term financial goal.

The stability of cash-like and short-term bond investments helps cash allocations serve these purposes. But this asset class offers the lowest long-term return potential, based on our Investment Policy Committee’s forward-looking capital market assumptions, which represent our expectations for the risk and return of each asset class over the next 30 years.

Additionally, as central banks cut short-term interest rates, yields on these types of investments are likely to fall, highlighting what’s called reinvestment risk – an elevated risk in overweight cash allocations. Therefore, while it’s important to hold enough cash to support your financial strategies, it’s also important you don’t have too much.

Put extra cash to work by first considering your strategic asset allocation targets. As early September showed us, market pullbacks are hard to predict. Aligning your portfolio with your risk and return objectives can help you avoid the temptation to move cash to the sidelines in anticipation of temporary market pullbacks, which risks missing some of the best days in markets.

Start by defining your portfolio’s strategic asset allocation targets according to your comfort with risk, time horizon and financial goals. We recommend taking a diversified approach to your strategic allocations, which can help reduce — but not eliminate — the your portfolio’s volatility.

If you’re saving for a long-term financial goal, such as a retirement or education, we recommend targeting a 1% cash allocation. In addition to its diversification benefits, small allocations can help you stay opportunistic during market volatility.

For the remaining 99%, we recommend maintaining appropriate allocations to 10 other asset classes that carry greater long-term return potential than cash. This can help ensure progress toward your financial goals.

Consider additional portfolio opportunities created, in part, by the central bank rate-cutting cycle:

• We recommend slightly overweighting equities, tilting specifically toward U.S. stocks. The Fed has suggested its rate-cutting cycle could extend through 2025 as inflation trends lower and growth moderates. With other central banks, including the Bank of Canada, also considering additional adjustments to bolster economic growth, we expect the backdrop to be supportive for stocks and bonds, although not without bumps along the way. However, in our view, the greater opportunity lies within stocks – specifically, U.S. large-, mid- and small-cap stocks.
  
  U.S. stocks have performed well over the last year and we believe their momentum is likely to continue, backed by the relative strength of the U.S. economy and corporate earnings, particularly when compared to developed overseas markets, such as the United Kingdom, Japan and Europe.
  
  We also expect U.S. stocks to be supported by broader leadership as the year’s laggards — particularly the segments of the market with more room for their valuations to expand as interest rates drift lower — play catch-up with the year’s top performers. Additionally, from a historical perspective, U.S. large-cap stocks have generally outperformed developed-overseas large-cap stocks in the quarters following the first Federal Reserve rate cut.
  
  U.S. small- and mid-cap stocks tend to be more economically sensitive than stocks of larger market capitalization but can help uphold the quality of a portfolio, as well. We view this balance positively as U.S. economic growth moderates but maintains its relative strength when compared to some other regions.
  
  Within international equity, we believe the balance between risks and opportunities has improved for the emerging-market stocks asset class. We view the breadth of the stimulus package announced by Chinese policymakers – which included interest rate cuts, property-market support and capital-market support – positively for the Chinese economy.
  
  While risks to China's economic growth remain, we believe it's likely additional monetary and fiscal policy support will follow, which could provide a further boost to emerging-market stocks, particularly given relatively low valuations within the asset class.
  
  Given these market dynamics, we've recently raised our recommended target for emerging-market stocks to neutral and lowered developed-overseas stocks to underweight.
   
• Within Canadian investment-grade bond allocations, we recommend raising the interest rate sensitivity. With economic growth softening and the Bank of Canada and the Fed expected to normalize policy by lowering interest rates over time, we expect taking greater interest-rate risk by extending the duration of your bond allocations to prove beneficial – bond prices rise as interest rates fall. Consider slightly reallocating from shorter-term maturities to intermediate- or longer-term maturities to position your portfolio for this rate-cutting cycle.

We’re here for you

Talk with your financial advisor about the importance of cash within your financial strategy, as well as the positioning of your portfolio in this environment. If you find you have cash to reinvest or an opportunity to rebalance your portfolio, your financial advisor can help identify potential market opportunities that can help keep your asset allocation aligned with your risk and return objectives and well-positioned for this rate-cutting cycle .

If you don’t have a financial advisor and would like to build an investment strategy grounded in the principles of quality, diversification and a long-term focus, we invite you to meet with an Edward Jones financial advisor.

Strategic portfolio guidance

Defining your strategic investment allocations helps to keep your portfolio aligned with your risk and return objectives, and we recommend taking a diversified approach. Our long-term strategic asset allocation guidance represents our view of balanced diversification for the fixed-income and equity portions of a well-diversified portfolio, based on our outlook for the economy and markets over the next 30 years. The exact weightings (neutral weights) to each asset class will depend on the broad allocation to equity and fixed-income investments that most closely aligns with your comfort with risk and financial goals. 

Diversification does not ensure a profit or protect against loss in a declining market.

Opportunistic portfolio guidance

Our opportunistic portfolio guidance represents our timely investment advice based on current market conditions and a shorter-term outlook. We believe incorporating this guidance into a well-diversified portfolio may enhance your potential for greater returns without taking on unintentional risks, helping to keep your portfolio aligned with your risk and return objectives. We recommend first considering our opportunistic asset allocation guidance to capture opportunities across asset classes. We then recommend considering opportunistic equity sector and Canadian investment-grade bond guidance for more supplemental portfolio positioning, if appropriate.