Investors’ love affair with past winners is insatiable. The ‘conventional wisdom’ on Wall Street is that US stocks, private equity, private credit, venture capital, and bonds will continue to be the ‘big winners’ in the years to come. Unfortunately, yesterday’s darlings almost never outperform in the future with the same risk-adjusted returns per unit of liquidity risk (this is important). Paradigm shifts typically happen slowly and quietly with most investors realizing after the fact. We think that one key shift will take place in the years to come.
The past 20 years has seen the prolific rise in momentum investing. In short, momentum investors ‘buy high’ with the hopes of ‘selling higher.’ For us at Astoria, this seems contrary to the basic principles of investing which are to ‘buy low’ and ‘sell high.’ We understand that mixing value and momentum in a portfolio can get investors higher up on the efficient frontier. We respect academic research as much as anyone. However, we find that most momentum investors forget to include the value portion in their portfolios, leading to inefficient portfolio construction.
Over the past 10 years, US stocks have produced exceptionally high risk adjusted returns while international markets have produced substantially lower returns. Of course, this has led to most buy-side managers overweighting US stocks and claiming they had ‘alpha.’ In retrospect, most of these managers were simply long momentum. The problem with momentum is that its downside risk can be quite harsh when the tides turn. Moreover, not hedging momentum with value means investors aren’t properly diversifying their portfolio risk.
We remain steadfast that holders of US stocks should hedge their risk by rotating a portion of their domestic holdings to international markets which offer better value. The Street is now advocating international markets to outperform the US in their 2020 outlook reports. Astoria, meanwhile, has been positioned this way for most of 2019. Right now, stocks globally are back to swimming in an ocean of liquidity. When there is an embedded put in the marketplace, going out the risk curve has historically been a good risk/reward.
Does anyone realize that the Greek, Russian, and Chinese markets are up 30-40% this year? Wait a minute: I thought the global economy was going into a recession this summer because there was $25 trillion of negative yielding sovereign debt and global PMIs were tanking? What happened to that theory? Remember, paradigm shifts occur slowly.
The days of being delta-long US stocks is coming to an end. Look overseas in 2020 and the years to come. You had a great 10 year run in US stocks. Don’t be greedy.
Best, John Davi
Founder & CIO of Astoria
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