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 is by John Davi, chief executive officer and chief investment officer of Astoria Portfolio Advisors in New York City.
As investment managers at Astoria, we meet regularly to monitor trends in the global economy. The net result of our most recent meetings is that we have reduced stocks, increased the credit quality of our bond portfolio, and increased the usage of alternatives across our dynamic portfolios.
Here’s a quick summary of how we currently see the world, and how we are allocating our ETF portfolios accordingly.
Big Picture: Stock Gains Likely To Slow Down
Increased concerns about global growth slowing and downside risks from trade wars resulted in deteriorating macroeconomic conditions in the first half of 2019. Due to the prevailing financial conditions, the U.S. Federal Reserve signaled it is open to cutting interest rates to stimulate growth and sustain the current economic expansion.
The S&P 500 index produced a return of 17.35% in the first half of 2019, its best first half since 1997. But the year-to-date index returns in the U.S. are highly unlikely to continue at this rapid pace.
We advocate a globally diversified, multifactor, multi-asset ETF portfolio, always thinking in the long term, of course.
Top ETF Picks
Some of our top ETF holdings across our dynamic portfolios include:
- U.S. Equity: focus on quality (WisdomTree US Quality Dividend Growth Fund (DGRW), iShares Edge MSCI U.S.A. Quality Factor ETF (QUAL) and JPMorgan U.S. Quality Factor ETF (JQUA)); banks (Invesco KBW Bank ETF (KBWB)); health care (Health Care Select Sector SPDR Fund (XLV)); and multifactor (WisdomTree U.S. Multifactor Fund (USMF) and Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF (GSLC))
- Global Equity: emerging markets (SPDR S&P Emerging Markets Dividend ETF (EDIV)); quality (WisdomTree Global ex-US Quality Dividend Growth Fund (DNL)); and China (iShares MSCI China ETF (MCHI) and WisdomTree ICBCCS S&P China 500 Fund (WCHN))
- Fixed Income: infrastructure bonds (Xtrackers Municipal Infrastructure Revenue Bond ETF (RVNU)); municipal bonds (Vanguard Tax-Exempt Bond ETF (VTEB)); investment-grade mortgage-backed securities (Vanguard Mortgage-Backed Securities ETF (VMBS)); investment-grade U.S. bond market (Vanguard Total Bond Market ETF (BND), SPDR Portfolio Aggregate Bond ETF (SPAB) and iShares Core U.S. Aggregate Bond ETF (AGG)); and short-term bonds (JPMorgan Ultra-Short Income ETF (JPST))
- Alternatives: merger/arbitrage (IQ Merger Arbitrage ETF (MNA)); long/short market neutral (AGFiQ U.S. Market Neutral Anti-Beta Fund (BTAL)); and gold & gold miners (VanEck Vectors Gold Miners ETF (GDX), SPDR Gold Trust (GLD) and iShares Gold Trust (IAU))
Here’s a more granular look at what’s driving our ETF selections (above) right now.
All Eyes On Yield Curve
A lot of attention is being paid to the fact that the U.S. yield curve is currently inverted. Historically, a negative yield curve implies investors expect future short-term rates to be lower as the Fed eases policy in response to a potential recession. According to J.P. Morgan Research, seven out of the eight U.S. yield curve inversions since 1960 were followed by a recession.
But while focus is on the three-month Treasury bill versus the 10-year Treasury inverted yield curve, consider that not all parts of the U.S. interest rate yield curve are inverted.
For instance, the two-year versus 10-year spread remains positive. In fact, the two-year versus 10-year spread has historically been more of a bellwether for predicting economic recessions, and it has been steadily steepening since the fourth quarter of 2018.
Sources: Bloomberg, Astoria Portfolio Advisors
That said, there’s plenty of concern overhanging the market; for example, the ongoing trade spat between the U.S. and China. There’s been a truce—for now—while negotiations are ongoing. The U.S. is holding off on imposing additional tariffs; China will continue to purchase agricultural products from the U.S. That’s the good news.
The bad news is that uncertainty remains, as there is no clear path toward a comprehensive resolution. This uncertainty will continue to overhang the global economic outlook and lead a drag on global growth in the second half of 2019 and into 2020.
Economic Data, Valuations & Portfolio Construction
Global economic data has also deteriorated in 2019. The U.S. economy isn’t immune to the global growth slowdown. The Atlanta Fed GDPNow Forecast Model is 1.50% as of June 28, 2019. On Aug. 1, 2018, this model was forecasting GDP to be 4.95%.
U.S. stock valuations are neither cheap nor expensive. According to FactSet, the S&P 500 Index forward P/E ratio is 16.6x as of June 28, 2019 and is slightly above the five-year average (16.5x) and the 10-year average (14.8x).
There is plenty for investors to worry about going into the second part of this year.
From a long-only ETF factor perspective, quality, size and momentum have outperformed the most thus far in 2019.
Source: ETFAction.com, data accessed on June 28, 2019
Int’l Equities: Valuations Attractive
On the back of an accommodative Fed, international developed and emerging market equities posted strong returns in the first half of 2019, but remain at attractive valuations. The Shanghai Stock Exchange Composite Index (China) increased by 20.96% (in CNY terms); the Euro STOXX 50 Index (Europe) rose by 19.81% (in euro terms); the MSCI Emerging Markets Index was up 11.06% (in USD terms); and the Nikkei 225 Index (Japan) increased by 7.53% (in Japanese yen terms).
In our view, emerging market equities (China in particular) remain attractive for long-term investors, as they are trading at a substantial valuation discount compared to the U.S. stock market. According to ETFAction.com, the iShares MSCI China ETF (MCHI) is projected to have 15.00% EPS growth based on 2019 analyst estimates, whereas the S&P 500 ETF Trust (SPY) is projected to have only 3.75%.
Fixed Income: Focus On High Grade
U.S. interest rates declined across various maturities in the first quarter. Given that the U.S. yield curve is relatively flat, ultra-short-duration bond funds are providing investors with a more attractive opportunity compared to longer-duration bond funds.
The Bloomberg Barclays U.S. Aggregate Bond Index is up 6.11% as of the end of the first half. We continue to prefer owning higher quality U.S. bonds across our portfolios. We maintain an overweight position in U.S. municipal bonds and U.S. mortgage-backed securities, both of which are highly rated. In fact, between 75-80% of our fixed income bonds across both Astoria’s strategic and dynamic ETF portfolios are rated either AAA or AA.
Commodities: Pick Wisely
Along with stocks and bonds, commodities posted positive returns in the first half. The Bloomberg Commodity Index increased by 3.83% although, once again, there were notable divergences across the complex. The United States Oil Fund LP (USO) increased by 24.64%, the SPDR Gold Trust (GLD) rose by 9.86%, the Invesco DB Base Metals Fund (DBB) climbed by 0.71%, and the Invesco DB Agriculture ETF (DBA) declined by 2.18%.
We have written that gold was attractive in a multi-asset portfolio, as it serves as a valuable diversifier during times of stress. As a reminder, our gold allocation helped soften our portfolio volatility in the fourth quarter of 2018, as gold rose 7.53% while the S&P 500 Index declined 13.52%.
Astoria Portfolio Advisors Disclosure: As of the time of this writing, Astoria held positions in DGRW, QUAL, JQUA, KBWB, XLV, USMF, GSLC, EDIV, DNL, WCHN, MCHI, RVNU, VTEB, VMBS, SPAB, AGG, BND JPST, MNA, BTAL, GDX, GLD and IAU.
Note that this is not an exhaustive list of holdings across Astoria’s dynamic ETF model portfolios.
Also note that Astoria maintains a set of strategic asset allocation ETF portfolios where the holdings vary from our dynamic portfolios. For full disclosure, please refer to our website.