Federated Hermes tilts toward value
Stock-bond model keeps 2% equity overweight but shifts from growth bias.
Federated Hermes strategists have adjusted their moderate growth stock-bond portfolio model, modestly shifting its tilt from growth to value to be better positioned for the early stages of an economic recovery that appears to be underway.
While the overall equity overweight in the PRISM® model remained at 2%, the asset allocation committee reduced the exposure to domestic large-cap growth from a 1% overweight to neutral and raised large-cap value from a 1% underweight to neutral. Similarly, the committee reduced domestic small-cap growth from a 1% overweight to neutral, while increasing domestic small-cap value from neutral to a 1% overweight. The committee also increased the allocation to Treasury Inflation-Protected Securities (TIPS) from neutral to a 1% overweight, funding that increase with a 1% reduction in cash.
The committee made the changes late Tuesday amid evidence that the sharp rotation of late from growth to value—the Russell 1000 Value has outperformed the Russell 1000 Growth by 479 basis points since Aug. 6—has legs, driven by four main factors:
- The economic rebound appears to be gaining momentum with robust housing activity, strong readings for both ISM manufacturing and services, better-than-expected labor market data, and improvement in several high-frequency measures of business and consumer activity such as railcar loadings and airline reservations.
- The virus data itself is improving meaningfully. On Monday, the U.S. reported just over 45,000 new Covid-19 infections, down approximately 30,000 since the July peak, with several states showing meaningful reductions.
- President Trump’s executive actions this past weekend likely dampened any risk from a short-term fiscal cliff and, in our view, increased odds of a more substantial legislative bargain in coming weeks.
- The Russian announcement that it was the first nation to approve a vaccine for public use renewed optimism for a vaccine by year-end. To be clear, its particular vaccine was approved without a Phase III trial, something that is extraordinarily unlikely to occur in the United States for important safety reasons. The bigger point is it appears increasingly likely that with most of the world’s best medical minds focused on Covid and several promising candidates in the wings, a vaccine with some reasonable effectiveness is likely in the coming months.
Collectively, these developments suggest the recovery not only is continuing but may be poised to accelerate, which should benefit more cyclical parts of the market including value and small-cap stocks. Small caps have the added benefit of historically performing quite well in the early stages of an economic recovery, outperforming their large-cap counterparts by an average of 25% in the first year after a recession market bottom.
We also think that relative value is on our side. Despite the 479 basis points of outperformance over the past several days, value is still underperforming growth on a year-to-date basis by nearly 29 percentage points, suggesting any rotation toward value could have quite a bit of room to run.
Unlike prior periods of value outperformance, which ultimately proved to be short-lived, the current move in the equity market has thus far been confirmed by price action in the bond market, where the yield on the benchmark 10-year Treasury has jumped 15 basis points from 0.50% to 0.65% in just five trading days. This is also reflected in precious metal prices, where gold is off over 5.5% since last Thursday.
On the TIPS side, the move to overweight was similarly designed to position the portfolio for recovery. Federal Reserve actions to date, as well as the potential for average inflation targeting and outcome-based forward guidance, are supporting easy financial conditions, economic recovery and asset reflation, all of which are supportive of TIPS.