Insight & Commentaries
Beginning in May, portfolios were allocated closer to the middle of prescribed ranges for stock and bond exposure as data showed signs of slowing. Bond allocations were modestly raised, defensive sectors were added, and domestic large-cap value was re-introduced into portfolios. Greek and European debt issues have been the focus of investor attention in recent weeks. Although we have no direct equity exposure to Greece, Ireland, Spain, or Portugal, we discuss the potential for Europe to find a “fix” to a difficult set of issues.
The pace of economic recovery has slowed based on our analysis of incoming data. The WCA Fundamental Conditions Index™, which evaluates changes in thirty different measures of financial and economic conditions, has slipped to a current reading near 65 from above 80 earlier this year (chart below). So long as this downward trend persists, a tactical portfolio posture with a somewhat broader diversification and closer to a neutral “risk / return” posture is appropriate. The shift was accomplished primarily through a modest increase in bond allocations beginning in May.
Since the Federal Reserve began its large-scale asset purchase program last fall, there has been a widespread and sustained improvement in most of the indicators we monitor. It is difficult to say exactly how much the program contributed to the improvement, but there is at least a coincident relationship between the Fed’s purchase of assets and the overall movement of much of the data in recent months. Importantly, aggregate profits have continued to increase, which is a positive indicator for future investment.
There are two questions that must be asked when making the tactical choice between stocks and bonds. This commentary focuses on what those questions are, how we attempt to answer them, and what it means for allocating assets between stocks and bonds. We also introduce the WCA Fear-Greed Index and discuss its use in tactical asset allocation.
Early this year, we saw our WCA Composite Conditions Index peak near 90 and begin a slide that lasted into the fall. That slide appears to have been arrested due to a combination of improving fundamentals and enhanced risk appetite in credit and capital markets. This week saw an improvement above 50, and we have increased equity exposure via emerging markets in our tactical models.
Equity markets have enjoyed a spirited rally since late August when the Federal Reserve announced further actions to stimulate growth via a new round of asset purchases euphemistically dubbed Quantitative Easing II (QE II). By our math, it seems that markets have already discounted more asset purchases than are likely, especially given some of the discord that seems to be following the announcement. In this commentary, we explore some of the potential pitfalls that may follow from QE II, and why this round of easing is not the same as the first round of easing during the heat of the…
Where we last left off in our August commentary, the Dow was at 10,644. Since then, the index fell to 10,000 and has bounced back to nearly 10,600. In other words, the equity market continues to churn and mark time as it contends with the challenges at hand – namely the ongoing liquidation of private sector debt, periodic concerns about sovereign finances, and large amounts of excess slack in the global economy. Especially hard hit has been America’s private sector workforce. All of this has conspired to produce a sub-par recovery that, in some ways, seems a lot like purgatory.
Despite the hoopla about the summer market rally, we continue to see a market that is basically without a trend. Bonds have generally outperformed stocks over the past six to nine months, and the momentum has come out of a broad array of indicators that we rely on for managing portfolios. In fact, our interpretation of the array of data we review has become more bullish for bond investors and less bullish for stock investors since our latest quarterly report.
Many who watch markets today draw comparisons to the early 1930s and conclude that the end of robust, global, Keynesian-style stimulus might drive today’s economy right back into the ditch. For those of us who have been concerned about the potential for a rapidly growing government to dampen the “animal spirits” of private enterprise, we are not entirely convinced that some restraint doesn’t come without its benefits as well.
What do troubles in the Euro-zone mean to U.S. investors? The answer is relatively simple. Growth rate expectations will likely be cut, dollar translation will have a negative impact on U.S. company profits, and dollar strength will make U.S. exports more expensive to Europeans. While there are near-term challenges for the European community, and the global growth story, there may be a silver lining in this for the United States, vis-à-vis the dollar and the U.S. recovery story.
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