Astoria Portfolio Advisors wrote an article on Sep 13th (click here) arguing that investors should tactically de-risk their ETF portfolios going into October. Subsequent to our article, the S&P 500 index fell 10% and we witnessed one of the worst sell-offs since the Lehman crisis.
The magnitude and force of the sell-off exceeded our expectations and simply put, we don’t think the economy is anywhere near as catastrophic as it was 10 years ago. We now believe that tactically turning bullish into year-end is a good risk/reward for US stocks on a relative basis. Here’s why.
US fundamentals remain intact. The S&P 500 trading at a forward P/E ratio of 15.7 is simply not expensive in our view. Bull markets don’t die when you have valuations at these levels. We acknowledge that higher interest rates indicate that there is competition for stocks and valuations may be capped in an environment of higher interest rates. Nonetheless, we believe US stocks are significantly more attractive than bonds.
Buyback season will accelerate now that the blackout period is over and corporate earnings season is ending. The 3rd quarter earnings season in the US will register close to 25% growth in profits and will match the 1st and 2nd quarter to produce one of the best quarters we have seen in over 10 years.
The US midterm elections were a significant overhang for the market and removed some key tail risks. A split congress may be a better outcome for markets as it could lead to more constructive conversations with China on trade policy as opposed to a red sweep scenario which some feared. If you don’t think that tariffs have damaged the global economy thus far, just observe returns for Chinese and Emerging Market equities since January 26th (FXI -25% and EEM -23%).
To fund the increase of additional US equities in our Multi-Asset Risk Strategy (MARS) ETF portfolio, Astoria reduced our fixed income holdings and EM equities.
We have been vocally bearish on bonds and we have been significantly underweight duration throughout 2018. We sold our VMBS (Vanguard Mortgage Backed Securities ETF) which has 100% exposure to AAA rated bonds and a duration of approximately 7 years. We simply prefer to keep duration as short as possible given an environment of rising inflation and higher interest rates. Does anyone realize that the Bloomberg Barclays US Aggregate Bond Index is currently on pace for its worst year since 1994? (click here)
We established a position in DGRW (WisdomTree U.S. Quality Dividend Growth Fund) which complements our other US equity ETFs, as well as our overall factor exposures. DGRW screens for companies with strong Return on Equity (ROE) & Return on Assets (ROA), high long-term growth estimates, as well as companies earning enough revenues to meet their dividend payment.
As of September 30, 2018, the WisdomTree U.S. Quality Dividend Growth Index has a ROE of 19.5% and ROA of 4.6% compared to only 15.6% and 3.6% for the S&P 500 Index. The Shareholder Yield (a measure of dividend plus buyback yield) for DGRW is 4.51% vs. 3.91% for the S&P 500 Index.
As mentioned, we also reduced our overweight in EM equities. We still believe that EM stocks serve a place in a globally diversified multi-asset portfolio. The MSCI Emerging Markets index is currently at a 40% discount to the S&P 500, near levels last reached in 2003. Astoria views EM stocks as a value play and historically value and momentum stocks have exhibited negative correlation (we place US equities in the momentum bucket). Admittedly, the recent underperformance of EM stocks vs. the US following the midterm elections is a bit worrying but we are actively managing our EM risk accordingly.
We are now approximately 70% allocated towards equities in our MARS ETF Portfolio.
In summary, positioning in US equities is a lot cleaner following the 10% correction and the elimination of key tail risks. Lastly, we think there is relatively more upside in US stocks on a short-term tactical basis in the months ahead.
Best, John Davi
Founder & CIO of Astoria
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