"Fortune favors the bold."
-Motto of the 80th Fighter Squadron
I read a study recently that looked at the allocations of the largest financial advisory firms in the United States. This study spanned some 40+ years. The results were telling.
Across the board, these firms adopted a largely 60/40 allocation. While there were firms that varied these allocations, the variations were rarely statistically insignificant. As an example, certain firms did get “aggressive” and set their allocations at 70/30. But, in effect, everyone followed the crowd.
The result of this lack of "boldness" in asset allocation was that performance across these firms was basically the same. When combined with associated fees, the outcome for the client was consistent underperformance over time.
This is not to say there aren't excellent investment advisors out there. There are. We are proud to count many as subscribers. In practice, though, it has been an industry that has produced mediocrity.
This is largely due to the philosophy of following the 60/40 portfolio allocation concept. The motivation for the original 60/40 portfolio came from a group of researchers that included Harry Markowtiz and William Sharpe. These two gentlemen both won the Nobel Prize for creating Modern Portfolio Theory (or MPT).
At the time, the rationale behind the ratio of 60/40 was that the total market had $1.50 in stocks and $1.00 in bonds. Therefore, an investor should allocate with a similar ratio to get exposure to the “total” market. Hence by its very nature, the 60/40 structure implied an average return for the client. A return that mirrored the “average” allocation of the market.
To be fair, it’s not like 60/40 has been a disaster. Interest rates have, until recently, basically gone straight down for decades, which has helped the bond portion deliver decent returns. Recent years have been a wake-up call for this allocation.
Our view is that investors should consider the Full Investing Cycle. There could be times when allocations to bonds go to zero. Or, conversely, there could be times when allocations to equities could be close to zero. Or (gasp!) there could be times when allocations are even made to things like commodities.
Back to the Global Macro Grind ...
One reason for being bolder in managing your portfolio is that the world is fragile. Take this morning as an example. The world’s largest bank, Industrial and Commercial Bank of China, has been hit by a cyber attack. As a result, the bank is now being forced to trade on a USB stick in the Treasury market.
This probably won’t bring the market down this morning, but it does speak to risks that are embedded in the system. They could be IT related, geopolitical, fundamental, or, as we shall see next week with the potential federal government shutdown, political. Should the U.S. government shut down due to a lack of funding, I suppose we can at least have consolation in the fact that it won’t be from a cyber attack.
Speaking of China, they have an economic problem emerging that U.S. investors can only dream about: deflation. According to data this week, China CPI was down -0.2% Y/Y in October and PPI was down -2.6% Y/Y (negative for the 13th straight month). Unfortunately, this is not the good kind of deflation.
Despite a consistent remedy of stimulus this year, demand in China, particularly from consumers, has been muted. In a deflationary environment, demand slows, prices slow, and corporate earnings slow even further. Alongside this, stocks typically fall even faster.
While they have bounced in the last couple of weeks, Chinese equities generally remain near their lows for the cycle. Unless the lack of demand and pricing power improves, any bounce will likely be short in nature.
Back in the U.S., we have the opposite problem, which is getting prices down sustainably. Chair Powell acknowledged as much yesterday, much to the chagrin of the FOMO crowd, when he said during comments at the IMF:
“If it becomes appropriate to tighten policy further, we will not hesitate to do so.”
He then went on to say that policy makers are committed to ensuring interest rates are high enough to return inflation to 2%, but they “are not confident that we have achieved such a stance.”
These comments combined with a less than successful Treasury auction sent yields higher. Yesterday, $24 billion in 30-year notes got less demand than expected at a lower price. Luckily, the U.S. Treasury will have plenty of opportunity to try again.
In the last year, debt on the federal government’s balance sheet has increased from $31.2 trillion to $33.7 trillion. This is an increase of some $2.5 trillion in the span of a year. To put it another way, the government has borrowed more than 3x times the 2008 bailout this year to fund its deficits.
This deficit spending, of course, comes at a time when GDP as of the most recent quarter grew at a +4.9% annualized SAAR and unemployment remains near generational lows of +3.9%. Imagine the money they will have to print when we go into a recession!
If you put it all together, maybe the fact there will only ever be 21 million bitcoins is intriguing. Incidentally, Bitcoin is now Bullish trend in our models.
At the moment, our asset allocation is a bit bolder than the 60/40 portfolio. These are the current Macro ETF allocations ranked by size that are updated daily in Portfolio Solutions product:
- FDRXX, TFLO, TBIL, BUXX, GLD, AAAU, RINF, IVOL, UUP, BTAL, PFIX, NLR, KBWP, SHY, IAK, URA, URNM, CANE, CTA, DWSH, INDA, SMIN, AMLP
Having a large allocation to high yielding cash type assets isn’t necessarily bold, but it is smart.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 4.63-5.13% (bullish)
UST 10yr Yield 4.49-4.97% (bullish)
UST 2yr Yield 4.83-5.13% (bullish)
High Yield (HYG) 71.27-74.39 (bearish)
SPX 4097-4383 (bearish)
NASDAQ 12,590-13,750 (neutral)
RUT 1 (bearish)
Tech (XLK) 161-177 (bullish)
Energy (XLE) 81.52-86.74 (bearish)
Utilities (XLU) 58.01-62.06 (bearish)
VIX 14.46-21.27 (bullish)
USD 104.78-107.05 (bullish)
Oil (WTI) 74.35-82.66 (bearish)
MSFT 339-369 (bullish)
NVDA 405-485 (bullish)
Bitcoin 34,007-37,169 (bullish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
