o 2017 was a highly unusual year. Nearly every major sector, country, region, and asset class had positive performance. This rarely happens! Why did this occur? There are 3 main reasons:
1. Earnings were strong globally
2. There was a tremendous amount of liquidity supplied by central banks globally ($2.2 trillion)
3. Inflation was relatively muted
o The global economic expansion is expected to continue in 2018 by a wide range of economists and research firms. In 2017, US Gross domestic product expanded, the unemployment rate fell, and upwards of 2 million new jobs were added.
The Conference Board US Leading Index Ten Economic Indicator is at 50-year highs!
Source: Conference Board, Bloomberg, Astoria.
US households net worth is also at 50+ year highs!
Source: Federal Reserve, Bloomberg, Astoria.
o It should be noted that the US expansion is already the second longest in history although the magnitude of the expansion hasn’t been nearly as impressive. The unprecedented amount of liquidity supplied by the Federal Reserve since 2009 is largely the driver.
International Equities
o The international expansion is much further behind the US and valuations overseas are more attractive and international central banks are currently still accommodative. Meanwhile, the US Federal reserve has embarked on raising interest rates and is largely expected to continue hiking rates in 2018.
o Cheaper valuations, earlier stages of the economic cycle, and more accommodative central bank policy is the primary reason why international equities are more attractive compared to US securities.
o Despite the 25%-35% rally in International Developed and Emerging Market equities in 2017, it’s important to realize that they have dramatically underperformed the US equity market since 2009.
o Whereas the S&P 500 is up nearly 400% since ’09, Europe and Emerging Markets are up nearly half that!
Source: Bloomberg, MSCI, Astoria
Morgan Stanley’s Developed Markets Cycle Indicator Remains Upward Trajectory
Source: Bloomberg, Morgan Stanley, Astoria
US Federal Reserve
o The US Federal Reserve Committee forecasts three 25 basis point rate increases in 2018. The US Federal Reserve has been incredibly diligent in resurrecting the US economy from the depths of the Great Recession in 2009. We think the probability that they raise rates more aggressively than what is implied in the market is low.
Fixed Income
o The Great Recession was a generational scare for many Americans who lost jobs, houses, or income. Because of the psychological damage, investors have largely crowded into defensive and high-income strategies despite the tremendous rally in equities as previously noted.
o Due to the basic economics of supply and demand, tremendous demand for income strategies has lowered bond yields to generational lows.
o Investors should be cautious with Fixed Income. Historically, this asset class provided high income, diversification, and were a hedge to equities. That is no longer the case. Nearly $2 trillion dollars has gone into fixed income strategies since 2009. Hence, all the historical attributes of fixed income are non-existent or slowly waning. The current yield of the US 10-year treasury is approximately 2.5%. The average since 1965 is approximately 6% (see chart below).
Source: Bloomberg, Astoria
o There are parts of Fixed Income that remain attractive and we are suggesting them in our client portfolios. Preferred securities, senior bank loans, high yield municipal bonds, and Emerging Market Debt are yielding between 4-6% and we believe offer value compared to traditional fixed income segments.
o European and Japanese government debt is negative yielding for short-term expiries and should be avoided like a plague.
o US rates are still very low by historical measures but are starting to increase because of 1) Fed hiking rates and 2) US economy getting stronger. We believe very long dated US Treasuries, are particularly, attractive to diversify portfolios. What was the only major asset class that outperformed in 2008 during one of the greatest recessions in the US history? The long US Treasury bond was up 33% in 2008 whereas most risky assets were down 30-50%.
Commodities
o Since March 2009, the Bloomberg Commodity Index has underperformed the S&P 500 by 392%. As a result, investors have largely ignored commodities ever since. Historically, commodities have done well during periods of rising inflation. We think, given we are in the latter stages of the economic cycle, it’s time to begin to allocate to commodities.
o There are numerous signs that inflation is increasing. We are watching the New York Federal Reserve Underlying Inflation Gauge which shows that inflation is nearing 3%. https://www.newyorkfed.org/research/policy/underlying-inflation-gauge
o Commodities are attractive in a multi asset portfolio given they are 1) uncorrelated, 2) severely under-owned, and 3) historically do well as inflation rises.
Commodities have underperformed S&P 500 since 2009 by approximately 400%!
Source: Bloomberg, Astoria Portfolio Advisors
Alternatives
o As noted above, 2017 was a highly unusual year and nearly every major asset class has had positive performance. However, 2018 will likely see divergences between asset class increase.
o Timing the market top (or bottom) is virtually impossible and the most sophisticated institutions don’t do it on a repeatable, systematic basis. Investors are more incentivized to not only stay fully invested but to consider asset classes which are uncorrelated to stocks and bonds to ensure their portfolios are properly diversified during market downturns. We believe it will be prudent in 2018 to include alternatives.
Gold
o Gold didn’t get the attention it deserved last year given the rip-roaring rally in equities in 2017. However, Gold produced a more than respectable 12% return mainly due to (1) a weakening U.S. dollar (2) concerns over international affairs (3) ongoing concerns over central banks debasing their currencies.
o Gold is an asset class that has been time tested for many centuries. We think it’s an attractive portfolio hedge against (1) the bitcoin bubble blowing up (2) hedge against risk events such as a North Korea bomb (3) inflation rising. Gold remains under owned particularly when compared investors recent love affair with cryptocurrencies. The big picture point is that gold remains uncorrelated to equities.
2018 Multi Asset Outlook
o Our view is that the 3 variants that were responsible for the large rally in global equities in 2017, will decline, on the margin, in 2018. We can’t emphasize how important the rate of change is for markets.
o Liquidity, which on the margin, will begin to deteriorate next year as the
1) Federal Reserve is expected to hike an additional 3 times in 2018
2) The Federal Reserve will also be faciliting their Quantitative Tightening program
3) The European Central Bank is expected to slow their Quantitative Easing program
o Liquidity has been the biggest driver of risk assets in recent years, so we would expect a reduction in liquidity to have negative implications, on the margin, for equities (certainly compared to the rip roaring rally experienced in 2017).
o The rate of change for inflation is turning. The Bloomberg Commodity index posted back to back positive years for the 1st time since 2010. The New York Federal Bank Inflation Gauge is nearly 3% (more color below).
o The year over year comparisons in earnings will be tougher in 2018.
o For more information about our 2018 outlook, please refer to
1. Our 2018 outlook report https://www.astoriaadvisors.com/single-post/2017/12/06/8-ETFs-for-2018
2. Our Bloomberg TV interview: https://www.bloomberg.com/news/videos/2017-12-27/the-year-of-the-hedge-for-etfs-video
Best, John Davi
Founder & CIO of Astoria
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