Bull Or Bear, Focus On Asset Allocations

August 19, 2014

However investors respond to where the market is heading, they need to stay invested.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Andrew Gogerty, vice president of investment strategies for Boston-based Newfound Research LLC.

As a quantitative firm, we generally refrain from waxing philosophical about economic conditions and policy. We subscribe to the theory that markets are chaotic—while trends emerge and persist, predicting those trends is nearly impossible.

We don’t particularly care that Dr. Frankenstein’s monster was an 8-foot tall, grotesque beast. By all clinical and scientific definitions, it was alive, and frankly, so is this market—at least for now.

So whether we should or should not have reanimated the market is a topic best left to economic historians. Instead, the question that needs to be addressed is, What now?

Generally, our view is to stay invested, and I’ll get to the reasons why and how we’ve added the PowerShares Multi-Strategy Alternative Portfolio (LALT) to our U.S. Equity Dynamic Long/Short strategy, but first let’s look at what’s happening now in the market.

In exploring that question, we find the true ugliness of the monster we have created:

  • The “recession babies”—21- to 35-year-olds—are so scarred by the last several years that they have the “most conservative portfolio profile of any age bracket under 65,” according to a recent report published by Bloomberg News.
  • In trying to control our monster, we’ve suppressed the yield curve. The yield on 10-year Treasurys—a terrific predictor of the forward 10-year annualized return for a constant maturity 10-year bond index, now sits at only 2.39 percent.

Combined, we have a frightening picture: A generation that should have the most aggressive profile has instead loaded up its portfolio with risk-mitigating asset classes with expected returns that barely stay ahead of inflation.

A Thoughtful Response

We believe by combining a quantitative approach with tactical flexibility, we can create an objective portfolio whereby we cast aside emotional biases and reintroduce return-generating asset classes into portfolios—all with the comfort that these solutions can adequately “de-risk” in times of crisis.

Among the most interesting developments this year was the violent strength and reversion of value equities in the second quarter. The large gap in relative strength of growth versus value equities—a trend that started in early 2013—collapsed in that quarter in dramatic fashion.

Going forward, we are now positioned for a return of strength in growth equities relative to value securities.

In the nontraditional income space, we see broad momentum tail winds across all asset classes. That said, our models currently tilt toward the bank loan, high-yield, preferred equities and mortgage REITs on a risk-adjusted basis. However, our models have continued the reduction in global dividend equities that began in the first quarter.

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