A Tactical Update: Whither Goest The Dollar

Our Fortress strategic asset allocation includes 5 distinct asset classes:

The Fortress allocation has historically produced better risk-adjusted returns than the traditional 60% stocks/40% bonds allocation.

The bond allocation is varied to adjust the risk of the portfolio. A Fortress allocation with 20% bonds has produced a higher return with lower standard deviation (volatility) than the 60/40 portfolio. In a world where bond yields are at or near all-time lows, we think that ought to be of interest to investors.

Our approach has lagged in performance over the last 10 years, which isn’t surprising since our portfolios put an emphasis on preserving purchasing power. In a world of low inflation-deflation in some areas – it isn’t surprising that holding gold and commodities in your portfolio produced a lower-than-historically-average return. In a world that also includes – ironically in light of those low-interest rates – massive government deficits and debt – we think that is a price worth paying. We think you will eventually – maybe sooner than you think – need that protection very much.

We make tactical changes to this Fortress Strategic allocation to produce our Citadel portfolios. We don’t think it makes sense to venture too far from the baseline of the strategic portfolio but we do think tactical changes can add value if they follow a logical methodology.

We use, among other tools, macro-economic research to tactically adjust our portfolios:

The most important factors for asset allocation are growth and the trend of the dollar. The uncertainty around those two variables these days is not unprecedented, but the only other comparable time was 2008. That might seem disconcerting at first, but remember that we did recover from 2008. It wasn’t a very robust recovery and it took a long time but we did recover. And we’ll recover from this virus too.

Economic Policy Uncertainty Index

Our tactical changes are informed by the economic environment as shown above, but identifying the environment properly can be challenging. As I’ve said many, many times, we aren’t in the business of predicting the future, because that is an impossible task, but we are trying to interpret the present and that isn’t as easy as it sounds. But it is worthwhile because the payoff for getting the big trends right can be enormous.

The dominant themes of the last decade are consistent with what we expect from a strong dollar environment outside of recession:

  1. US outperforming International
  2. Growth outperforming Value
  3. Large Cap outperforming Small Cap
  4. Developed Markets outperforming Developing Markets
  5. Technology outperforming Everything
  6. Equities and Bonds outperforming Commodities/Real Assets
  7. Stocks outperforming Real estate

Those trends are a result of a (mostly) strong dollar environment with fairly steady growth. Growth has waxed and waned over the last decade but until recently it just oscillated around a 2% trend.

The dollar has been generally strong but the rise was concentrated in a surprisingly short period of time in 2014 and 2015.

Since that surge, the dollar index has mostly traded in a range with a couple of forays outside the box. But a relatively strong and stable dollar is actually a pretty good investment environment as long as you own the right things, those being the things in that list of dominant themes of the last decade.

Since the panic phase of the virus recession passed, the dollar has been weakening back to the bottom of the range that has prevailed since 2015:

We don’t know yet whether this short-term trend will turn into an intermediate one, and eventually a long-term one. But the move has been sufficiently powerful that we have made tactical changes to take advantage of it. We look to momentum in markets to confirm the dollar trend so we are not all-in on a weak dollar outcome. There are still strong dollar trends in place in some areas as shifts like this aren’t generally uniform.

There are plenty of reasons, as our Jeff Snider is fond of pointing out, to believe this short-term downtrend will be just that – short-term. But a 9% drop in the space of four months cannot be ignored.

1 2 3 4
View single page >> |

Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.


Leave a comment to automatically be entered into our contest to win a free Echo Show.