For years, “defense” in portfolios—i.e., allocations to cash and core fixed income holdings—has meant a willingness to accept extremely low returns. But after many years of economic recovery, we finally have reached a point where defensive allocations once again provide a reasonable yield. Many noisy political topics have dominated the investment discourse in 2018, but underneath that noise and volatility, the drum beat of rising interest rates in the U.S. has been steady and consistent. After nearly a decade sitting near zero, the effective Fed Funds Rate (as tracked by the St. Louis Fed) rose above 50 bps at the end of 2016, and since then has ticked up to 180 bps as of June 30, 2018. While still low by historical standards, the Fed’s hiking has spurred rates elsewhere (the 10-year Treasury yield briefly poked above 3% in April, and now sits between 2.8% and 2.9%). Source: Bloomberg. As a result, it may make sense for investors to consider decreasing equity allocations and increasing fixed income allocations within their portfolios. (As always, such decisions are highly dependent on a given investor’s specific circumstances.) Three Factors Supporting a Shift from Equities to Bonds We still believe that equities offer healthy opportunity, and the fact that the current economic expansion is simply “old” has never been a sufficient reason for us to lose confidence in it. But beyond the economic cycle’s age, several factors suggest that a more defensive mindset is worth considering: Valuations are elevated. This is true in various regions, but particularly true in the U.S. Robust Q1 2018 earnings growth improved the valuation picture for U.S. stocks, but they are still pricy by historical standards. It is worth noting that valuations are more reasonable in developed international and emerging markets; however, U.S. valuations are critical given the large role that U.S. stocks play in most investors’ core equity allocations. The economic expansion may be reaching its limits. Rising interest rates, a flattening yield curve, continuing inflationary pressures and unemployment falling to multi-decade lows—we believe that all of these facts are indicative of an economy that is at or beyond full potential. The flattening curve has received a good deal of attention recently (the 2-year/10-year Treasury spread has narrowed to a mere 25 bps as of December 31, 2016), while the more traditional measures of employment and inflation have offered reasons for caution for some time. (We always emphasize, however, that we can’t predict the near-term direction of the economy and don’t base investment decisions on such predictions.) Meaningful political and economic risks exist for stocks. We discussed some of these risks at length in our 2018 asset allocation report, “Confronting the Unknown.” While the military threat in North Korea has, for now, appeared to recede, the potential impact of protectionist trends on global trade has only strengthened since we issued our report earlier this year. Source: Bureau of Labor Statistics for unemployment data; Bureau of Economic Analysis for inflation data; U.S. Treasury for yield spread data. With all of this in mind, we believe that bonds have gained some ground on stocks in terms of the risk and potential reward each asset class represents. The opportunity cost of defense is lower today than it has been in many years. The views expressed are those of Brown Advisory as of the date referenced and are subject to change at any time based on market or other conditions. These views are not intended to be and should not be relied upon as investment advice and are not intended to be a forecast of future events or a guarantee of future results. Past performance is not a guarantee of future performance and you may not get back the amount invested. The information provided in this material is not intended to be and should not be considered to be a recommendation or suggestion to engage in or refrain from a particular course of action or to make or hold a particular investment or pursue a particular investment strategy, including whether or not to buy, sell, or hold any of the securities or asset classes mentioned. It should not be assumed that investments in such securities or asset classes have been or will be profitable. To the extent specific securities are mentioned, they have been selected by the author on an objective basis to illustrate views expressed in the commentary and do not represent all of the securities purchased, sold or recommended for advisory clients. The information contained herein has been prepared from sources believed reliable but is not guaranteed by us as to its timeliness or accuracy, and is not a complete summary or statement of all available data. This piece is intended solely for our clients and prospective clients, is for informational purposes only, and is not individually tailored for or directed to any particular client or prospective client. Yield-to-Worst (YTW) is the lowest potential yield that can be received on a bond without the issuer actually defaulting. The YTW is calculated by making worst-case scenario assumptions on the issue by calculating the return that would be received if the issuer uses provisions, including prepayments, calls or sinking funds. This metric is used to evaluate the worst-case scenario for yield to help investors manage risks and ensure that specific income requirements will still be met even in the worst scenarios. Bloomberg Barclays U.S. Aggregate Bond Index is a market capitalization-weighted index, meaning the securities in the index are weighted according to the market size of each bond type. Most U.S. traded investment grade bonds are represented. Municipal bonds, and Treasury Inflation-Protected Securities are excluded, due to tax treatment issues. The index includes Treasury securities, Government agency bonds, Mortgage-backed bonds, Corporate bonds, and a small amount of foreign bonds traded in U.S. Bloomberg Barclays Indices are trademarks of Bloomberg or its licensors, including Barclays Bank PLC. BLOOMBERG, BLOOMBERG PROFESSIONAL, BLOOMBERG MARKETS, BLOOMBERG NEWS,BLOOMBERG ANYWHERE, BLOOMBERG TRADEBOOK, BLOOMBERG BONDTRADER, BLOOMBERG TELEVISION, BLOOMBERG RADIO, BLOOMBERG PRESS, BLOOMBERG.COM and BLOOMBERG LAW are trademarks and service marks of Bloomberg Finance L.P., a Delaware limited partnership, or its subsidiaries