My ride into Boulder this morning featured baby bunnies emerging from their burrows, crabapple trees brightly blooming, and trout rising for a midge hatch in Boulder Creek –a pleasant reminder that the earth is warm with spring and a cycle has started anew.
We homo sapiens love cycles; they provide structure in an otherwise fairly unpredictable existence. Therefore, it comes as no surprise that the homo sapiens employed by the largest investment firms are desperately trying to label, define, and predict this current economic cycle; particularly because this U.S. business expansion just hit 93 months long (compared to the average expansion since 1945 of 58 months).
Five minutes of listening to prognosticators on CNBC would have a viewer thinking that the strategy du jour is to act as springtime bunnies do when spotted; run and hide.
We agree that both U.S. stocks and bonds look expensive (more on this to follow). Investors have spent the better part of the past seven years pulling stock market returns from the future to the present. However, now is not the time to “hide” in cash which is paying next to nothing.
Widening the perspective to include world economies, it’s easy to see that giving too much credence to past cycle lengths can be hazardous to your piggy bank. Just take Australia, the Netherlands or our friends to the North as examples!
We are underweight U.S. stocks within BSW growth portfolios – in favor of developed foreign and emerging market stocks. This has worked to our benefit so far in 2017. Through April 17th, BSW growth portfolios have outperformed our benchmark, the ACWI (All Country World Index), which notched a respectable 6.65% gain for the time period. For every $1 invested within BSW growth, about 44 cents is invested in Large, Mid and Small-cap U.S. stocks and 56 cents is invested in stocks within foreign developed countries (think: Europe, Britain, Japan, Australia) and emerging countries (think: China, India, Taiwan, Brazil, Mexico).
We are seeing real value in stocks overseas. Many foreign economies and stock markets have not fully recovered from the ’08-’09 downturn, allowing much more room to run. Manufacturing, employment, and lending measures are all firmly in the green across most overseas regions we track. These positive signs are taking place in a foreign-stock-goldilocks-environment, where the U.S. dollar has stopped appreciating and inflation is no longer a problem.
The only thing holding back developed foreign stocks at this point is sentiment. To this end, we acknowledge that political uncertainty, especially in Europe, is at an all-time high. The French election now looks to be a four horse race. We have learned not to trust election polls and therefore are not trying to predict the outcome. However, we assign a fairly high probability that investors around the world will welcome any certainty out of the elections; after which point European stocks should quickly re-value to the upside to reflect their true underlying growth prospects and high dividend yields. Even with the current uncertainty, the MSCI EAFE, an index of developed foreign stocks, has outperformed the S&P 500 thus far this year: up 7.04% vs 5.54% for the S&P through April 17. Emerging markets have one-upped them both, gaining 12.03%.
While we don’t entirely dismiss the constant bearish chatter (remember that some of this chatter comes from investors with an agenda), BSW is always looking at the investment environment through a risk lens.
What do I mean by this?
As an example, too many investors have been driven to dividend stocks, high-yield bonds and MLPs (master limited partnerships; think: oil pipelines and storage tanks) from core fixed income – chasing yield and performance. Too much focus has been on contribution to return and not contribution to risk. These investors will wake up one morning and find out that to get the 4%+ yields, their portfolios are now down 5%+ because they took too much risk to get that yield. Their portfolios were linked to elevated stock-like risk and not more reasonable fixed income-like risk.
To piggyback on David Wolf’s excellent April 5th post on volatility, there is rarely a period where clarity reigns, the coast is clear, and we can invest with high levels of certainty. Along these lines, the BSW Investment Policy Committee constantly asks, “What if we are wrong?” and structures investments to account for this. While return on investment is paramount, we always make sure that clients have investments in their portfolios that will insulate and protect on the downside, in addition to investment ingredients that will take advantage of market upside.
By having a diverse mix of asset classes with different risk profiles (that do not move in lock-step), we are able to embrace and “monetize” volatility through tactical and semi-annual rebalancing. (See Below)
As illustrated above, contrary to intuitive thought, a portfolio of stocks and bonds can outperform a portfolio of 100% stocks over time, by taking advantage of volatility and the non-correlated nature of different asset classes. Rebalancing the portfolio over time when asset classes become overweight or underweight versus their targets can improve long-term returns.
This also means that as asset allocators, we don’t have to conjure images in a crystal ball and be “spot on” when entering the market. In other words, our initial purchase of stocks will not be our only entry point – far from it. We use market dips over time to repurchase stocks at lower prices, which when executed with discipline, over and over, can be meaningful.
So bring on the naysayers that are predicting the “inevitable” downturn in the business cycle! Given that our clients are long-term investors, we stand ready to rebalance on weakness, take advantage of further market upside and everything in between!
Thanks for reading and happy spring!
Craig Seidler – Director Public Investments