Asset managers turn to defensive positioning as equity prices soar

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Asset managers overseeing trillions of dollars are cautioning clients to take a defensive position heavy on bonds in the face of rising equity prices and the expectation that the Federal Reserve is increasingly unlikely to cut interest rates much further.

A key Vanguard model released as part of the $10tn asset manager’s 2025 outlook now calls for financial advisers and certain wealthy individual investors to allocate 38 per cent of their portfolios to stocks and the remainder to fixed income. That recommendation is down from 41 per cent for 2024 and 50 per cent for 2023, tantamount to flipping the popular 60/40 portfolio on its head.

“For that investor who is willing to take a little bit of active risk and deviate from their long-term policy portfolio, we think de-risking would make sense,” Todd Schlanger, a senior investment strategist at Vanguard, said in an interview.

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Vanguard’s latest forecast was cemented after the November election of president-elect Donald Trump and Republican allies in Congress, which led to an initial stock market bump that has since ebbed. While investors have been bullish about the prospects of Trump’s “Maganomics,” economists have put forward gloomier prognostications fuelled by worries over elevated inflation and interest rates.

Vanguard’s support for greater fixed-income exposure follows two years of roaring US equity performance — a bull run that has made stocks look too costly to some. The S&P 500’s price-to-earnings ratio, a commonly used valuation metric, has grown from about 19.2 in September 2022 to nearly 30 as of this week.

Invesco’s solutions arm is also advising increased fixed-income exposure, as well as focusing equity holdings in defensive sectors such as healthcare, consumer staples and utilities.

Charles Shriver, a portfolio manager at T Rowe Price, said his team remains predisposed to equities but has tilted towards value stocks, eschewing pricey growth companies in favour of “more attractively priced areas”.

“Stocks look extremely expensive on a historical basis,” said Will Smith, a high yield manager at AllianceBernstein. “It’s going to be really hard to have stock returns over the next decade nearly as high as they’ve been over the past decade.”

The approach of preferring bonds over equities was out of favour last year when the S&P 500 wrapped up its second consecutive strong year, Schlanger acknowledged, noting that Vanguard’s “time-varying asset allocation” model has a 10-year horizon in mind.

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“You can have these periods of underperformance,” he said. “But we would still view the model as doing what it’s supposed to be doing and trying to manage the risks that are out there, recognising that as US equities have continued to go up in price, the potential for lower returns and the potential for drawdown increases.”

The S&P 500 enjoyed a bounce after Trump’s decisive November victory, propelling it to a record high just under 6,100 on December 6. But markets have been muted since then, and 2024 ended on a down note for equities with no “Santa Claus” rally to be found.

“The election trades are already losing momentum,” said Alessio de Longis, head of investments for Invesco Solutions.

“In a nutshell, our view is that growth is decelerating,” he added. “The evidence that inflation is weakening aggressively is not really there.”