This article is part of a regular series of thought leadership pieces from some of the more influential ETF asset managers in the money management industry. Today's article is by Michael McClary, chief investment officer of Akron, Ohio-based ValMark Advisers, which markets the "TOPS" brand of asset allocation models.
Do you remember the first time you got into trouble and your parents couldn't, or didn't, swoop in and bail you out? This memory may be analogous to the experiences of investors recently.
For many children and adolescents, time growing up is spent testing boundaries and learning through making mistakes and encountering challenges. However, childhood is also defined by the structure that parents can provide.
Many children in the U.S. are blessed to have adults in their home who pay attention to how much they are eating, sleeping and doing their homework. Likewise, mom and dad were there alongside many of us, if we did something we weren't supposed to.
Central Banks As 'Helicopter Parents'
As a parent, we are told not to be "helicopter parents." We have to let little Johnny get skinned knees, just like we did. For fear of ridicule, even those of us who might have some helicopter traits don't readily ask to wear that moniker.
For the past few years, with steady Fed stimulus, the U.S. stock market has felt a little bit like childhood. However, the stock market is, undoubtedly, the real world. As an adult, meeting basic levels of net worth, you can open an online trading account, short stocks and take on near-limitless financial liability.
The economic intervention of central banks since the 2008 financial crisis is well-publicized. In previous pieces, we have highlighted research outlining the financial and qualitative benefits and drawbacks from central bank intervention into the world's economies and stock markets. I think few would argue that they haven't been acting like helicopter parents.
For Wall Street's most successful and proud CEOs to be bailed out by the government in the financial crisis, they must have felt like being the star quarterback and having your mom come bail you out in curlers and sweatpants in front of your friends.
Where Did The Helicopter Parents Go?
With the Fed's recent interest rate increase, the central bank seemed less likely than we have seen for many years to step in and bail out the market from daily volatility.
Reality is the end of quantitative easing in the U.S., which portends the helicopter parents are gone for now. Or, at least they are not as reliable as they have been.
Mommy has likely stopped making sure there is a nutritious meal for dinner; Daddy is probably not going to talk to your coach because coach is not playing you enough; and your teachers largely don't care if you skip your homework and fail the class.
Beyond the direct impact of the divergent economic policies globally, there have been numerous secondary and tertiary effects. For example, partially due to the massive amounts of U.S. Treasurys that emerging market countries have sold to defend their currencies, Deutsche Bank believes that U.S. Treasury yields will go higher.
This is a big change for most investors. Didn't we all get used to immediate hangover relief? Over the last few years, the relief rally has been as expected as grandpa falling asleep on the chair after Thanksgiving dinner.
For many investors, seeing the market follow down days with further weakness in 2016 is as surprising as seeing grandpa instead drink a few Red Bulls and start dunking basketballs on the driveway basketball hoop.
A Return To Normal
For many professional investors, however, this is more of a return to normal. We understand that markets ebb and flow, that cycles come and go, that investors do sometimes lose money and that the S&P 500 is not supernatural.
Many have highlighted that valuations on U.S. stocks were heightened. Many were concerned that valuations would leave stocks vulnerable if the economy softened and the Fed didn't bail us out. From time to time, the market makes movements that don't seem to be in the numbers. We believe, however, that the recent pullback in U.S. stocks is not outside of the financial models.
Post-Helicopter Parents World
We believe that global diversification is the most optimal strategy at this time. We caution investors from reaching for the recent past. In searching for the comfort of central bank intervention, many investors will gravitate toward concentrated strategies that attempt to make fire in monsoon rains.
We believe that the relative valuations of many diversifier asset classes complement core, long-term domestic exposure well.
For example, the following table shows current P/E ratios for several popular global indexes, then ranks them monthly as a percentile over the last 20 years.
|S&P 500||S&P 500 Value||S&P 500 Growth||S&P
|S&P Small Cap||MSCI
Source: Bloomberg, as-of 12-31-2015
As you can see, emerging markets were less expensive than they had been two-thirds of the time for the last 20 years (as of 12/31/2015). Market performance year-to-date has reduced their sale price further.
Don't Forget About Upside Risk
Few investors profited greatly from the monumental shifts in value of the U.S. dollar, interest rates and oil. While the shifts were significant, they didn't come wrapped in boxes stamped "Guaranteed to happen."
U.S. stocks have largely outperformed the rest of the world due to the rise in the U.S. dollar, low interest rates and cheap oil. What if these extreme valuations shift from tail winds to head winds? What if the economy slows globally, but international stocks outperform the S&P 500 simply because the dollar drops by 7%? What if emerging markets outperform the S&P 500 by 20% because oil more than doubles in value?
We are all taught that "what goes up, must come down." In investing, however, it is important to note that gravity is not a factor, and cycles go both ways.
ValMark Advisers Inc. is the manager of the TOPS Portfolios of ETFs. ValMark started managing "TOPS" separately managed accounts of ETFs in 2002. The firm manages more than $5.1 billion in ETFs for retail and institutional clients in multiple investment products. Email: [email protected]; phone: 800-765-5201. For a complete list of relevant disclosures, please click here.