Global Asset Allocation Update - Friday, May 18

There is no change to the risk budget this month. For the moderate risk investor, the allocation between risk assets and bonds is unchanged at 50/50. There are, however, changes within the asset classes. We are reducing the equity allocation and raising the allocation to REITs. 

Based on the bond markets there has been little change in the growth and inflation outlook since the last asset allocation update. Based on the stock market – at least until yesterday – the future is so bright, simple shades won’t do; welding goggles are required. Well, at least that’s the view from the Nasdaq, which even after yesterday’s 2.5% shellacking is up over 3.5% in just the last month. 

Other than the tech stocks though, all the upside action was outside the US with Europe taking the lead. The French election, along with some improvement in European economic statistics, pushed European stocks up 9.3% in the last month. More generally, international stocks, as represented by the EAFE, were up a bit over 5%. EAFE small cap and emerging markets were also higher while the S&P 500 lagged, up just 0.3%. Foreign bonds were also leaders with developed market foreign bonds up the most (BWZ, +2.1%). Local currency EM bonds were also higher, continuing a trend that started right after the election sell-off. Three month returns are led by international stocks and US bonds followed by gold. Not exactly a ringing endorsement of the accelerating US economy meme.

Much of the outperformance of international markets was driven by the now falling dollar. The dollar index is down about 2.67% since the last update (-5.5% YTD) with the sell-off accelerating in lockstep with the political chaos that is the Trump administration. The overwhelming consensus coming into this year was that the dollar had to go higher because rates had to go higher (bonds down in price). Both of those widespread expectations were based, to some degree, on expectations that the new administration would be able to ride into town and get things done. It hasn’t exactly worked out that way as someone – see herehereherehere, etc., etc. – has predicted repeatedly since the election. Almost all the rise in the dollar since election day has now been reversed. Bonds, I would point out, have quite a ways to go yet to achieve the same.

Our portfolios were positioned for a weak dollar outcome before the election although that wasn’t the reason for the tilt. We don’t generally spend a lot of time on elections because the reactions to them – positive or negative – are generally short lived. We were positioned for a weak dollar because we started to see a shift in long term momentum at the beginning of last year. Commodities – and particularly gold –  were outperforming stocks for most of last year until the election. European outperformance started in the middle of last year, well before election day. Indeed, the election merely interrupted that trend as visions of tax cuts danced in investors’ heads. Now the previous trends are reasserting themselves as expectations for tax reform and other pro-growth measures in the US fade and the cyclical rebound overseas gains some momentum.

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