The investing environment remains challenging. Equity valuations are high after a 6 year extraordinary bull market. Bonds have been in a bull market for 35 years and yields, though off their 2012 lows, remain at historic extremes. After a 7 year, 700% bull in oil from 2001 to 2008, it gave back 90% of gains in 6 month. Oil followed this up with a 5 year bull and again gave back 90% of gains in 6 months.
Sometimes, as investors, it’s necessary to just invest in the best place possible given a lot of historically poor choices. In these times of poor valuations, we want to stay under-invested as embedded risk is higher than normal. We want to be nimble and try to avoid getting steam-rolled in markets that can drop 80% or more in less than 6 months.
Here are some places I think we can find relative value.
Equities:
US Equities have seen the best regional equity performance performance, but also have the highest valuations. US valuations relative to non-US stocks are at extremely high levels relative to the past 25 years. The US is performing better today than the rest of the world. Perhaps US strength can help the rest of the globe. A tilt toward Global Ex-US stocks has a good relative chance of providing portfolio value.
Fixed Income:
With rates at historic lows and the Fed contemplating a rise off the zero bound, one wants to be very careful in bonds. If you do venture out the yield curve, consider inflation protected bonds. Oil has plunged over 60% and much of the headline inflation weakness is tied to this major commodity. Perhaps, more importantly, much of the embedded future inflation expectations have dropped coincident with oil markets. If this recent soft patch is just a lull, which I believe, then interest rates may rise and bond portfolios would not perform well. But, if the economy does prove resilient, oil may have found a bottom. Higher oil means higher inflation expectations. Stable oil means headline inflation creeps up toward core inflation. Both scenarios would be relatively good for inflation protected bonds. In bond portfolios, consider upping the allocation to TIPs versus nominal bonds to use rising inflation expectations as a hedge against the potential of good growth and rising rates.
