The S&P 500 has been setting all-time high records, markets are pulling back their hopes for a March rate cut, and investor optimism about the direction of both the stock and bond markets has soared.

There are a lot of reasons to be positive, but also risks. We discuss the key themes we’ve heard on the road as well as how we see investors positioned around them.

The December FOMC meeting was the dovish pivot markets wanted– and not without reason. Recent measures of inflation, such as 3- and 6-month annualized core PCE, is running close to the Federal Reserve’s target of 2% and continue to reinforce the narrative that inflation is normalizing.¹

However, markets got ahead of themselves pricing in a March cut and have been forced to walk back some of December’s exuberance: market-implied likelihood of a rate cute fell from 80% to 20% following Powell’s pushback during the January FOMC. ²

Stickiness in price components, such as medical care and shelter, coupled with a strong U.S. consumer leads us to believe the Federal Reserve will not be so quick to cut. Our expectations are for a June cut, and a cumulative 100bps by year-end – extending the pause period and providing investors another opportunity to extend duration. ³

And they’re taking this opportunity: the average advisor extended duration by about a year in 2023, ending the year with a duration of around 5. But 25% of advisor portfolios have a fixed income allocation with a duration of 4 years or lower, and advisors remain overallocated to the short-term bond category. ⁴

We don’t think the tech trade is over: many of these companies still boast the revenues and earnings to command their spot at the top of the U.S. equity market, in addition to their exposure to longer-term trends such as.

We advocate for maintaining exposure to technology via a preference for high quality U.S. companies, but also playing a potentially broadening equity market rally with select value sectors. We believe the largest opportunity lies in healthcare and financials – both of which we believe may benefit from improving positioning and earnings.

Our Target Allocation model portfolios team expressed a similar balance: maintaining an overweight to quality and technology while adding to large-cap value during its most recent rebalance.

For investors who prefer an active approach to factor rotation, the iShares U.S. Equity Factor Rotation Active ETF (DYNF) has also come up in many of our January conversations. Currently, the fund disfavors the value and small cap parts of the market while maintaining a strong preference for Quality, Large Cap, and Momentum.

While this year’s elections will have significant impacts on public policy, the impact on markets in the long term has historically been limited.

Equity markets crave certainty. When there is lack of certainty in outcomes, we tend to see market volatility rise ahead of elections. Policy uncertainty looks to be the primary culprit, with dispersion at its widest following elections in which power changes hands.

However, with two known entities likely to secure their party nominations, this election may well break from history. Policy priorities from each are well known, as are their respective track records in office – an unusual situation. As a result, investors may dust off old playbooks, assured by policy certainty.