Topic Tags: Asset Allocation

2016 Asset Allocation Winners and Losers

January is a time to reflect on the past year and assess what went right and what went wrong, and asset allocation is no different in this regard. Elevated valuations at the start of 2016 did not hold back U.S. equities as they climbed to record highs; small caps were the outright winner with a 21% return. These smaller cap companies received a post-election boost as they were expected to be less affected by the strengthening dollar and potential trade policies enacted by Trump, since they do not typically conduct much international business. The knock-on benefits of a potential lower corporate tax rate also helped propel small-cap equities higher after the election.

January is a time to reflect on the past year and assess what went right and what went wrong, and asset allocation is no different in this regard. Elevated valuations at the start of 2016 did not hold back U.S. equities as they climbed to record highs; small-caps were the outright winner with a 21% return. These smaller-cap companies received a post-election boost as they were expected to be less affected by the strengthening dollar and potential trade policies enacted by Trump, since they do not typically conduct much international business. The knock-on benefits of a potential lower corporate tax rate also helped propel small-cap equities higher after the election.

Internationally, slowing growth concerns were a determinant of performance. The “anti-establishment” sentiment seen in Europe was a major source of uncertainty. Emerging markets were the most appealing in terms of relative valuations, which helped them deliver double-digit returns after three consecutive negative years.

Lastly, fixed income was led by high yield bonds which rallied back from an end-of-year dip in 2015, with lower quality issues leading the way. Long duration bonds were also a top performer within fixed income, as were bank loans. After the Trump victory revived inflation expectations, TIPS became a topic of discussion. Realistically, as policies will take time to implement, inflation will manifest slowly and will be only one of a few indicators to monitor.

Of course, 2016 is behind us and investors are at this point more interested in what the markets will bring us in 2017. While predicting market winners and losers each year is a difficult exercise, it is safe to say that we will not see a repeat of 2016 asset class performance, and maintaining a diversified portfolio with disciplined rebalancing will help to mitigate risk no matter what happens across the global markets.

The Impact of Trump’s Victory on Capital Markets

November 2016

To the surprise of pollsters, analysts, and much of the American public, Republican presidential candidate Donald Trump trampled predictions by winning the presidential election in stunning fashion.

The long-term impact of Trump’s presidency on financial markets is impossible to predict at this point, given the amount of uncertainty around his expected policies. However, the short-term dynamics surrounding his election win are starting to emerge, and we share with you what we are seeing and hearing in the market in this newsletter.

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The Difficulty of Timing the Stock Market

Since markets hit their 2016 troughs back in February, they have continued to rally and hit new all time highs over the course of this year. With the upcoming election, talks and discussions surrounding a market bubble and looming recession, investors have begun to ask themselves if now is the right time to start lowering their equity market allocations to better position and protect themselves.

Since markets hit their 2016 troughs back in February, they have continued to rally and hit new all-time highs over the course of this year. With the upcoming election, talks and discussions surrounding a market bubble and looming recession, investors have begun to ask themselves if now is the right time to start lowering their equity market allocations to better position and protect themselves.

Of course, reducing equity exposure in anticipation of a market downturn requires close to perfect timing on the front end — reducing equity exposure — and on the back end — renewing equity exposure. The cost of getting this timing wrong can be dramatic, especially if some of the days on the sidelines end up being some of the strongest days of market returns on record — which is especially true on the days coming out of a correction. Our chart above illustrates the dramatic shortfall which can emerge if investors are out of the market on notably high returning days in the market. Clearly, despite the inherent volatility of the stock market, it is better to be fully invested in the market than trying to time the market in anticipation of market corrections and subsequent recoveries.

Note: Returns calculated using daily price returns of the S&P 500 Index over the past 50 years, for the period ending September 30, 2016.

BREXIT: The Results and What’s Next

June 2016

On June 23rd, the United Kingdom (UK) shocked markets with its vote to leave the European Union (EU). The Remain vote lost to the Leave vote, 48.1% to 51.9%, with a strong turnout throughout the UK. Younger voters sided with the Remain camp by a wide margin, while older voters supported the Leave camp (Exhibit 2). In the weeks leading up to the referendum, global equity/credit markets and the British pound experienced positive price movement in anticipation of a Remain verdict. Using polling information and odds makers as indicators, investors were caught off guard at the Brexit result, leading to dramatic losses for risk assets on June 24th.

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Any Good Deals Out There in the U.S. Equity Market?

Given the current market environment right now, there are no real compelling “buy” opportunities, as measured by a variety of valuation metrics. On top of that, economic growth is slow, yields are low, and equity returns are weak. As such, one of the primary conversations we have with clients is around rebalancing, both at the broader asset class as well as between the underlying components of each asset class.

Given the current market environment, there are no real compelling “buy” opportunities as measured by a variety of valuation metrics. On top of that, economic growth is slow, yields are low, and equity returns are weak. As such, one of the primary conversations we have with clients is around rebalancing, both at the broader asset class as well as between the underlying components of each asset class. In particular, we have recently spent a lot of time discussing the relative valuations of large-cap and small-cap U.S. equities in an effort to identify the more attractive opportunity in today’s market.

In this week’s chart, we examine the P/E ratios of U.S. large-cap and small-cap stocks and compare today’s values to their 20-year averages, removing outliers for when earnings are near zero or negative. The intuition is that the farther today’s P/E ratio is from the long-term average, the more (or less) attractive it is from a valuation standpoint: a reading below the long-term average signals a discounted price, whereas a reading above the long-term average indicates the index is expensive. As seen in the chart, both are near their historical averages, suggesting there isn’t an overly compelling case for either.

How they have gotten to this point over the last 2–3 years, though, is very different. Large-cap companies have slowly returned to this average as a result of investor caution as well as the gradual — but consistent — rise in earnings from 2011 to 2015. Recently though, earnings have slightly fallen for larger companies, which has caused some concern for investors. Small-cap stocks, on the other hand, feature more volatile valuations, with swings in earnings the primary explanation of volatility. In theory, during times of “risk-off” sentiment, large-cap stocks should outperform smaller companies, and vice versa for “risk-on” periods. But with ambiguous market data and valuations so similar to historical averages, investor sentiment is unclear, thus making it extremely difficult to truly identify compelling value in either sleeve of the U.S. equity market.

2016 Market Preview

January 2016

Similar to previous years, we offer our annual market preview newsletter. Each year presents new challenges to our clients, and 2016 is off to a volatile start with equity markets down significantly, oil dropping below $30, the Fed poised to further increase interest rates, and fears of a China slowdown rippling through the markets. However, other headlines will emerge as the year goes on, and it is critical to understand how asset classes will react to each new development and what such reactions will mean to investors. The following articles contain insightful analysis and key themes to monitor over the coming year, themes which will underlie the actual performance of the asset classes covered.

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