Attached are our latest views on global financial assets. Trade wars dominated the headlines in Q2. We are not experts on trade protectionism (we doubt many are). At Astoria, we are militant about focusing on doing what we do best: portfolio construction, macro-economic & quantitative research, building diversified portfolios, and investing for the long run. At Astoria, we strive to take your hard-earned capital and invest in securities where there is a margin of safety. Astoria believes the combination of your long duration capital and our long duration investment strategies is a unique and an attractive risk/reward. Do not hesitate to contact us with any questions you have.
Best, John Davi
Founder & CIO of Astoria Portfolio Advisors
General Overview of Risk Assets
Astoria typically does not put out market commentary recapping what previously happened as our research is forward-looking by design. Given the increase in volatility in Q2, we have been asked for our interpretation of what’s transpired and what it means for multi-asset investing for the balance of 2018.
Market pundits have argued that trade wars are the reason why the markets have sold off aggressively in certain parts of the world (namely EM equities). While trade wars are important and on the margin negative, Astoria believes the real drivers behind the weakness are 1) liquidity is declining in ‘18, 2) global growth has decoupled 3) inflation is rising, on the margin.
Astoria’s big call for 2018 was that investors need to hedge their risk assets. Astoria’s Founder and CIO went on Bloomberg TV in December to warn investors. You can find our interview here: https://www.astoriaadvisors.com/blog/bloomberg-tv-interview
Market pundits have argued that the economy is in the latter stages of the business cycle. At Astoria, we think the cycle is over. Astoria believes the economy has entered into a new cycle where there is no longer an embedded put from central banks. QE provided investors with a floor to financial assets and unfortunately that floor is being removed.
Astoria was vocal that last year’s highly unusual year (high Sharpe Ratios, strong returns across all assets – with virtually no volatility) would not be repeated in 2018. In November 2017, we warned investors about the implications of less liquidity in the capital markets system. For those interested in viewing our previous pieces, you can find them here:
In Q1 2018, Astoria migrated away from our core market cap weighted ETFs to multi factor ETFs to put our portfolios into a more defensive position. https://www.astoriaadvisors.com/blog/we-are-no-longer-bullish-on-market-cap-weighted-etfs
President Trump continues to play chicken with China. Astoria is not an expert on trade wars. Even if some claim to be experts in the trade protectionism space, there is a reasonably high probability those experts aren’t skilled in portfolio construction. Astoria has modeled for higher volatility in 2018 as we are investing in liquid alternatives, gold, cash, and assets which have lower correlations to traditional equity and fixed income markets.
Given where front end US rates are trading, short duration spread products are providing investors with an attractive place to park money. We think the front end of the US curve is significantly more attractive compared to a traditional credit product such as US high yield. Our bearish views on US high yield credit remains intact.
Astoria has been vocal in owning commodities. There has been tremendous dispersion YTD partially due to trade wars, as well as due to fundamentals. Lean hog (+44%), Crude oil (+22%), Lean hog and feeder cattle (+17%) have led the rally while gasoline (-21%) and soybean (-17%) led the decline. Astoria has taken an indexed based approach by using the Bloomberg Commodity Index which is only down 0.90% YTD.
Astoria continues to watch copper (-10% in June) as an indicator of global economic slowdown.
Concerns of Fed rate hikes and its balance sheet reduction has led to a disruption in funding markets. The US Libor OIS spread rose 475% increase from November 2017 to April 2018 (see chart below). It is estimated that the Fed’s balance sheet will decline by $1 trillion in 2020. We remain very concerned about the method in which the Fed’s balance sheet is eventually reduced.
Source: Bloomberg, Astoria
Is Astoria bearish? No. We are managing our portfolios to invest in equities where there is a margin of safety and we are harvesting these strategies in a cost-effective manner for the long run. In Astoria’s view, the overarching theme in one’s portfolio should be value, quality, and mixing in other factors (we like momentum, carry, & trend) to further enhance your portfolio risk characteristics.
What do we expect for the H2 2018? We are not market timers, forecasters, or attempt to predict what could happen. Given our Founder’s background in Quantitative & Derivatives research, Astoria looks at all the distributions of outcomes and assigns probabilities to them. Our goal is to take our investors’ long duration capital, harvest our investment strategies in a cost-effective manner, and to include portfolio diversifiers to smooth out our portfolio returns over varying economic cycles. The quantitative factors that Astoria is harvesting are persistent, pervasive, robust, and have been time-tested for decades.
Next, we will go through each of the major asset classes to review what happened in Q2 and our views going forward.
Market volatility picked up in the 2nd quarter as trade wars escalated, global growth diverged, the US Dollar strengthened, and US yields continued their upward trend. The rally in the US dollar negatively impacted Emerging Markets to a large degree. The US Federal Reserve continued with its rate hiking program and the European Central Bank (ECB) announced its intension to end its Asset Purchase Program in December 2018. Both measures will result in liquidity declining which we argued in our Q4 ’17 and Q1 ’18 commentaries would negatively impact equity prices. Astoria continues to advocate investors to diversify their portfolios to help navigate turbulent markets and to help accomplish their long-term investment goals.
US Federal Reserve
As widely expected, the US Federal Reserve raised interest rates by 25bps in the June FOMC meeting and forecasts two more rate hikes before year end which will bring the Fed Funds rate to 2.25-2.5% by the end of the year. The Federal Reserve Chairman, Jerome Powell, has indicated that he would take a ‘symmetric’ approach to inflation. This implies that the Fed will allow inflation to rise above 2%, at times, to encourage economic growth.
Given the robustness of business confidence and tight labor markets, Astoria believes the Fed is on track to deliver a 25bps rate hike at each quarter in 2018. The Federal Reserve has now hiked interest rates seven times since December 2015. It’s important to keep in mind the big picture. Over the past two years, the global economy and financial markets have absorbed Fed actions reasonably well. Moreover, in the context of accomplishing your long-term investment goals, short term moves are difficult to predict and provide an opportunity to rebalance one’s portfolio.
President Trump has escalated trade tensions further by indicating that a 10% tariff would be placed on $200 billion of Chinese imports, in addition to the 25% tariff on $50 billion of imports announced in March and to be implemented on July 6. The Chinese Ministry of Commerce has threatened to apply U.S. goods with their own tariffs. While we are not experts on trade protectionism policies, we would point out that China owns over $1 trillion of US government securities (approx. 30% of all outstanding securities). Nobody stands to win in a trade war and we continue to grapple with the longer-term investment implications.
US Earnings & Valuations
US economic data has been strong in recent months. The Conference Board US leading 10 economic indicator index remains at 50-year highs (see chart below), the NFIB small business survey remains near a record high (see chart below), unemployment is at the lowest level since 1969, and the Atlanta Fed GDP Now Forecast is 4.086% as of July 2, 2018. The Labor Department reported that for the first time ever, there are more open jobs than there are unemployed Americans.
There was a clear rotation out of cyclical orientated stocks and into more defensives in the second quarter. We expect this rotation to continue as investors grapple with trade war concerns.
The S&P 500 forward P/E ratio was 16.1x as of June 2018 which is inline with its average over the past two decades (16.1x). Broadly speaking, Astoria does not think US large cap stocks are expensive at these valuation levels.
US equities have outperformed their global counterparts by a significant margin in recent months. From March 29, 2018 thru June 29, 2018, the S&P 500 Index was up 3.4% while the MSCI All Country World Index Excluding the US Index was down 3.4% (in USD terms).
The Bloomberg Dollar Spot Index (BBDXY) rose 4.9% in Q2. We would caution investors that a combination of a strong dollar and further escalation in trade wars could negatively impact consumer and business confidence in the future.
Source: Bloomberg, NFIB, Astoria
Source: Bloomberg, Conference Board, Astoria
The global synchronized economic recovery is over. There are growing divergences emerging in global growth with the U.S. producing strong data but a cyclical slowdown in the Europe, Japan, China, and certain Emerging Markets.
While the S&P 500 rallied 3.43% in Q2 2018, international markets were mixed as the Euro Stoxx 50 (Europe) rose 3.37% (in Euro terms) and the Nikkei 225 (Japan) rallied 5.53% (in Japanese Yen terms). A stronger US dollar hurt the performance of Emerging Markets as the MSCI Emerging Markets Index declined 7.78% (in USD terms) during the second quarter of 2018. Another driver behind the weakness of Emerging Markets is due to China showing signs of slowing down. The CSI 300 index was down 14% (in USD terms) in Q2. Meanwhile, the ECB announced it will end its Asset Purchase Program in December 2018, although it doesn’t foresee a rate hike "through the summer" of 2019.
As mentioned in our previous commentaries, the international expansion is much further behind the US and oversea valuations are relatively more attractive. This is part of the reason why we have been positioned our portfolios to include more International and Emerging Market Equities. Whereas the S&P 500 is up 349% since March 09, European (in EUR terms), Emerging Markets (in USD terms), and Japanese equities (in JPY terms) are up only 153%, 176%, and 251% respectively.
The PE ratio for the MSCI ex US stocks is 13.0x while the average over the past 2 decades is 14.4x. This compares to the US which is 16.1x.
US yields continue to rise higher. Yields on the 2-year, 10-year, and 30-year US Treasury Bond now stand at 2.54%, 2.86%, and 2.98% respectively. While the front end of the US interest rate market is becoming more attractive, investors should be cautious with traditional credit products. Historically, traditional fixed income products provided investors with high income, diversification, and were a hedge to equities. These characteristics are not as prevalent at present. Over $2 trillion dollars has gone into fixed income strategies since 2009. Hence, these historical attributes of fixed income have ostensibly waned.
There are select parts of fixed income that remain attractive. As such, we are suggesting them in our client portfolios. Variable preferred securities, senior bank loans, short duration high yield municipal bonds, and emerging market debt are yielding between 4-6%; in our view, these offer value compared to traditional credit segments.
Trade tariffs by the Trump Administration has altered the supply and demand balance in many commodity markets. A stronger US dollar was another headwind for commodities. A continuation of trade protectionism polices could further increase the probability of a full-blown trade war which could lead to a further risk-off period across all asset classes.
Despite commodities being negative impacted by a strong dollar and trade war concerns, we continue to believe on a longer-term basis they remain attractive given they are 1) uncorrelated, 2) under-owned 3) historically do well as inflation rises and 4) perform well during the later stages of the economic cycle.
Year to date, there has been high dispersion in commodities. From January 1st through the end of June, crude oil has gained over 25%, base metals were down 9.4%, agriculture was down 3.8%, gold is down 3.9%, and the broad base Bloomberg Commodity Index is down 0.9%.
Source: Bloomberg, Astoria
Astoria has had an out of consensus view that inflation, on the margin, is rising. We are closely watching the New York Federal Reserve Underlying Inflation Gauge which continues to tick higher. The latest reading (as of May 2018) is 3.27%. Refer to the NY Fed’s website for further information https://www.newyorkfed.org/research/policy/underlying-inflation-gauge.
While gold has declined by 3.9% in the 1st half of 2018, the metal remains attractive in a multi-asset portfolio as it serves as a portfolio diversifier against (1) geopolitical tensions (2) ongoing concerns over central banks debasing their currencies (3) rising inflation (4) they remain uncorrelated to equities. Gold is an asset class that has been time tested for many centuries and it remains under-represented in the majority of investor’s portfolios. Moreover, the demise of the digital asset market could provide a tailwind for gold.
Timing the market top (or bottom) is virtually impossible to do on a repeatable, systematic, and scaled basis. Investors are more incentivized to stay fully invested and to incorporate asset classes which are uncorrelated to stocks and bonds to ensure their portfolios are properly diversified during market downturns. Astoria continues to advocate liquid alternatives given their low correlation to traditional stock and bond markets.
We look forward to your feedback on our commentary. Please reach out to us with any input as we continue to strive to provide our clients and the marketplace with relevant and useful insights.
Best, John Davi
Founder & CIO of Astoria
For full disclosure, please refer to our website: https://www.astoriaadvisors.com/disclaimer