Global Asset Allocation Views – Q2 2018
It really did not take long for volatility to show up in 2018. After a first couple of weeks of parabolic moves in the equity markets, inflation and a fast pace of rate rises began to scare investors. These moves, along with the ongoing tit-for-tat tariff battle between the United States and China, has led to the first market correction (a move of 10% or more from the peak) since February 2016 when markets were fearful of a tightening China and slumping oil prices. Even with this pullback the S&P 500 ended the quarter down only 1.22%. Fixed income markets were hit the hardest as the yield curve flattened and rates rose at an aggressive pace fueled by inflation fears. Alternatives and international equities held up the best in the quarter, while large cap growth and emerging market equities even finishing the quarter positive.
So what should we expect going forward? I currently take the view of being optimistic in the long-term (12-18 months) due in part to global synchronized growth and the ongoing benefits from the Tax Cuts and Jobs Act. However, in the short-term I am taking a realistic approach as we maneuver tweets that move the market and a potential trade war with China or with Mexico/Canada over NAFTA.
As we go through rough patches, it is important to stick to your investment strategy. Ours can be summarized below:
- Diversify your portfolio to minimize risk
- Rebalance when your portfolio weights shift dramatically
- Make tactical allocation changes when the opportunity arises and the additional risks are well understood (see below under Asset Allocation Views)
Key Themes:
- We continue to support Equities over Fixed Income. Equities will benefit from global synchronized growth while Fixed Income will underperform as the Fed tightens.
- Within Equity we continue to favor International over Domestic. International equities are favored due to a weaker dollar and more attractive valuations.
- Within Fixed Income we favor Emerging Market Debt over core Fixed Income (U.S. Treasuries, Mortgage-Backed Securities, and Investment Grade Corporates). Emerging Market Debt benefits from a weakening dollar and strong balance sheets.
Key Risks:
- Trade – In previous editions of my views I have mentioned this as a risk, and though a full blown trade war is unlikely it is still a tail-end risk that could lead to a global recession. It is important to think about how interconnected the global supply chain has become and the impact tariffs will have on shifting production to other locations and cost impacts that would harm consumers. The most likely scenario seems to be some concessions from China on opening up their markets to U.S. goods with both President Trump and Prime Minister Xi being able to claim some type of victory. Stay tuned to any updates as this escalates or dies off.
- Flattening Yield Curve – the yield curve has continued to flatten with the spread between the 2- and the 10-year treasury at only 50bps (.5%). A flat yield curve has not been a problem in the past, however when the curve inverts (when shorter-term rates are higher than longer-term rates) recessions tend to follow.
- Inflation – inflation fears led to the initial market pullback at the end of January and is still worth monitoring. So far, wage growth is still somewhat muted and core inflation is still below the Fed’s 2% target. It will be interesting to see if the Fed tries to get ahead of inflation and tighten faster or let inflation run a little and raise rates at a slower pace.
Asset Allocation Views
Equities
Large Cap (Growth) Momentum – Overweight
Large Cap Value – Slightly Overweight
Large Cap Dividend Growth – Neutral
Mid Cap – Neutral
Small Cap – Neutral
Europe – Slightly Overweight*
Asia Pacific – Slightly Overweight
Canada – Neutral
Developed Small Cap – Overweight
Emerging Markets – Overweight*
Fixed Income
U.S. Treasuries – Slightly Underweight*
Investment Grade Corporates – Slightly Underweight*
Mortgage-Backed Securities – Slightly Underweight
High Yield Debt – Neutral
Emerging Market Debt – Overweight
*changes since last quarter
View Change
- As Emerging Markets have outperformed I have increased the tactical weight to match actual portfolio weights. To make room I decreased European The European Central Bank is potentially viewed as tightening early next year and recent economic data has come in softer than expected.
- I reduced Investment-Grade Corporates as spreads have tightened to record lows vs Treasuries and the risk/return potential is tilted to the downside. I shifted the allocation to Treasuries as it provides a better buffer during volatile times, though I am still underweight core bonds in general.
Written by Antonio Belmonte
These are the opinions of Antonio Belmonte and not necessarily those of Cambridge, are for information purposes only, and should not be construed or acted upon as individualized investment advice. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. The strategies discussed herein are not designed based on the individual needs of any one specific client or investor. In other words, it is not a customized strategy designed on the specific financial circumstances of the client. However, prior to opening an account, Cambridge will consult with you to determine if your financial objectives are appropriate for investing in the model. You are also provided the opportunity to place reasonable restrictions on the securities held in your account.