Insight & Commentaries
This report discusses current recommended allocations in light of evolving fundamental conditions. A special focus is presented on the upcoming election, debt issues, and the fiscal cliff along with an update on the WCA Fundamental Conditions barometer, which showed the first month of improvement in September following six months of slippage. The report also includes a long-run outlook with forecasts for a wide range of asset classes.
We expect a debt ceiling agreement to be met, since the consequences of one not being met would be unthinkable. Still, markets remain highly sensitive to events in Washington.
Fundamental conditions appear to be gaining some momentum in the back half of the year, and equity valuations remain within reason. After a slower spring and summer, which recently caused the Fed to cut their forecasts, we are again seeing signs of improvement in most of the data we review. Foreign manufacturing seems to be leading the cycle this time, but domestic conditions are holding relatively steady. Therefore, portfolio allocations continue to emphasize shorter duration bonds, while gold remains sidelined, and equity allocations get a boost.
Earlier this year, we reduced and subsequently eliminated gold from portfolios based on price, anticipated policy changes, and poor relative price momentum. We remain underweight gold ahead of the Federal Reserve’s September Federal Open Market Committee meeting. We continue to monitor gold, however, and are maintaining the metal as part of our long-run policy allocations. We continue to see its value as an alternative asset under a variety of market conditions, since gold prices and the dollar often move in opposite directions from one another.
The first half of the year saw stocks move higher, led by domestic shares, while bonds, cash, and commodities (which typically do not move in lock step with stocks) generally lost ground.
Improving fundamentals last September led us to overweight stocks in portfolios at that time (see Upgrading Outlook, September 11, 2012). Our call was to remain overweight stocks as fundamentals were accelerating. Momentum was interrupted in April, and portfolio weights were returned to their long-run stock / bond target mixes and portfolios rebalanced.
Recognizing that interest rates remain still at very low levels relative to underlying growth, continued special attention to portfolio duration is still warranted, in our view. Accordingly, we have taken actions to shorten duration further in model portfolios by reducing holdings of longer-term bonds and reallocating a portion of those assets to shorter-duration floating-rate securities.
March economic data is disappointing so far, but far from recessionary. Last week’s retail sales report for last month was -0.1% compared to an expectation for a +0.3% increase and last month’s gain of 0.4%. Taken by itself, one month’s slippage in sales would not alter our assessment for continued slow growth. However, a series of other recent reports suggest a clear loss of momentum headed early in the second quarter.
We are entering the fifth year of recovery, with most of the data improved since last summer’s slump. Large amounts of deficit-financed spending and central bank liquidity are contributing to economic activity and lifting asset values. With the stock market back to pre-crisis levels, we want to look at how various “pillars” of the recovery are holding up.
Our analysis of incoming data suggests a decent start to 2013. These observations form the basis for our forecast as we start the year. Even though a policy misstep could always derail the economy, we expect a positive environment for investors because valuations appear reasonable and economic fundamentals are gradually improving.
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