April 7, 2016
Where Do We Go From Here?
Earlier in 2016, many believed the Fed was embarking on a policy towards interest rate 'normalization', but a funny and unexpected event occurred beneath the headlines. The global equity markets did the normalizing while the U.S. Fed has only talked. Once again the markets are leading the Fed in action!
As the Fed slowed its normalization rhetoric, the U.S. equity markets have recovered all of their losses they experienced at the start of 2016. Leading the returns in 2016 are Utilities and Consumer Staples. This narrow leadership illustrated below has been in place for some time and many of the individual company constituents of these sectors have been expensive but continue to move higher. Valuation levels on both sectors are well above historical averages with the utility sector trading at 16X earnings and consumer staples at 22X earnings. These valuation levels have led our portfolio managers on our Dividend Income equity portfolio to significantly underweight these areas. But are these valuation levels of these sectors giving us a clue to future potential return opportunities here in the U.S.? Rest assured that we are still finding opportunities across the U.S. in sectors such as financials, industrials, and technology. But what can we expect in the way of returns?
Time to Go Abroad?
The U.S. economic fundamentals have clearly led the world out of 2008 and capital has moved to the safety and stability of this great nation. As other economies continue to struggle with no growth and negative interest rates, the U.S enjoys low employment, a steady but slow GDP rate, low inflation and low interest rates that remain supportive to economic activity. However, these advantages may already be priced into many domestic equity valuations as witnessed by Utilities and Staples. If one has a long term time horizon and can exercise patience of buying low with increased volatility, international diversification appears to make a lot of sense at the current time. The below chart published by Research Affiliates estimates the forward looking expected return and volatility of major economies around the globe. I would draw your attention to what appears to be very unexciting opportunities here in the U.S. relative to other parts of the globe. No wonder investors are anxious and seem unhappy; muted future returns are never well received. Based on this chart, strategists should start consider greater international exposure despite the potential pitfalls if they desire future return.
Red· United States
Green· Emerging Markets
Blue· Developed Markets
We Have Heard This Before - When Is A Good Time to Increase International Exposure?
The fact that international developed and emerging market equities appear attractive on valuation and future expected return factors is not new information to most investors. We have all heard this for some time but the U.S. continues to shine. International exposure continues to be a major drag on total portfolio performance. International markets on the whole continue to underperform the U.S. even with this known information of lower valuations and improved expected return. So with all of the problems in international economies, when is the time to increase the weighting? Is it a value trap that just remains frustrating and leads to continued under-performance? Is the added volatility worth the risk?
These are all great questions on investors' minds and to us it does appear that given the valuation disparity across the globe, it is just a question of WHEN and not IF that international and emerging markets drive global returns. So how do we logically increase this exposure without running the risk of getting caught in a value trap that leads to total portfolio under-performance?
We developed the Braver Global Tactical Balanced strategy to provide investors answers to many of these questions and provide a gateway to international markets if they are performing. This strategy was developed as a 'go anywhere' global equity and fixed income portfolio. It is a quantitatively driven portfolio that consists of multi-algorithms analyzing over 65 equity and fixed income asset classes around the globe. Instead, the algorithms seek to identify the best performing stock and bond segments around the globe and the algorithms 'pair' the asset classes to identify best opportunities. The models will allocate capital to those stock and bond segments that provide the best return prospects each month. If the domestic markets continue to dominate as they have for 7 years, the models should identify these trends and stay more domestically oriented. However, if the international and emerging capital markets finally begin to trend higher and lead the way, our models should also identify these trends and begin to allocate more internationally. This 'tactical', unbiased and unemotional approach may avoid the pitfalls of static investing and 'value traps' that may be inherent in international investing today. This strategy may help investors and their advisors better manage the 'When' question on international. The whole world is an opportunity and this portfolio seeks to take advantage of the broad opportunities and not be limited by geographical borders.
The U.S. is unlikely to dominate global returns indefinitely and I hope this idea of a global tactical asset allocation strategy (GTAA) is helpful to your portfolio construction. I encourage you to contact our consultants for more information on this strategy and how it can be used in your client portfolios.
In the meantime, I am very happy to report that our national pasttime lives on here in Red Sox Nation as Big Papi embarks on his final tour!
Go Sox - and bring on some warm weather!
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