Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.
For regular SAA and TAA portfolios, the next re-balance will be on Monday, September 30, 2013. You can also find the re-balance calendar for 2013 on ‘Dashboard‘ page once you log in.
As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.
Please note that we now list the next re-balance date on every portfolio page.
The New Normal and Portfolio Risk Management
In the aftermath of the financial crisis in 2009, PIMCO started to use ‘New Normal’ to describe their prediction of economy growth and its implication on investments. Though not all of the predictions from the theory panned out correctly, the theory did serve as a framework for discussion and prediction. As most of our readers might have known, we do not claim to be economy experts (and neither to be investment experts) and we believe no one can predict the future of economy and markets correctly most of time, let alone 100%. For that purpose, we think the New Normal theory has served its purpose.
Recently, PIMCO’s CEO El-Erian published an article that revisited the New Normal (one of our users alerted us about this). We made a summary in this article PIMCO’s El-Erian: New Normal with Stable Disequilibrium and T-Junction. This newsletter would like to discuss its implication on portfolio management, especially in risk management.
First, what is the original New Normal? The original New Normal theory claimed that the developed countries will go through a long period of anemic economic growth in a high unemployment deleveraging environment while emerging economies will recover much faster. Though US recovered faster than what the original New Normal would have predicted, up to now, in terms of economic development, the old New Normal has been relatively correct. What turned out to be much off is the stock and bond market developments: US stocks, along with European and Japanese stocks, have recovered nicely. Again, this just reinforced our belief: one can not rely on experts’ prediction in investing.
El-Erian now believes that the multi-speed economies (developed countries slow growth and emerging markets faster growth) is at a “stable disequilibrium”; that is, an economic and financial configuration that superficially appeared stable but was in fact increasingly unstable in its key foundations and drivers. He presents five reasons on this. Interested readers can refer to the PIMCO’s El-Erian: New Normal with Stable Disequilibrium and T-Junction for a summary.
New Normal: T-Junction Growth Paths
He further describes the following implications:
These considerations have all led us to conclude at Pimco that the new normal is morphing—from an unsatisfactory low-level equilibrium to a stable disequilibrium. And we believe that a good way to visualize the underlying dynamics is through the use of a “T-junction” construct, with its two principal components; namely, the eventual end of the current road, and the possibility of two quite distinct and contrasting outcomes thereafter.
He illustrates the T-junctions for each of the four largest economies:
- Europe: the two options: a more complete union that can deliver growth and jobs OR a messy reorganization with risk of major economic, financial, political and social dislocations.
- Japan: short road to the neck of the “T”: either sustain the burst of growth OR growth will peter out and leads to financial instability.
- US: either continues the safe deleveraging and higher growth OR another recession and structural high unemployment and other social issues.
- China: either succeed in adapting its growth model (from external to internal) OR hard to sustain high growth, causing social and political instability.
Basically, unlike in previous periods, these economies are still in a transitionary stage that can be destabilized by each other. This is especially true among the conflicting growth models they rely upon.
Furthermore, we believe that the developed countries, especially the US, might be at a better position among others in the coming several years. The reason is that the US can afford to grow at a gradual pace to restructure its economy while others, Europe, Japan and China (and other emerging markets) all are at a very unstable juncture that requires much more radical reforms to escape from current situations.
How to Position Your Portfolios
- Proper risk level that you can live with comfortably. This is should be independent of whatever investment strategy you are using.
- Diversification among major asset classes. In our opinion, in risk asset portion, US stocks should be overweight, just like in our Strategic Asset Allocation – Optimal.
- Tactically adjust risk exposure using a strategy such as our trend based Tactical Asset Allocation(TAA). Though there are many drawbacks for using a TAA, its ability to deliver reasonable returns in a uncertain environment and good or even stellar returns in a raging bull market while avoiding big loss in a serious environment makes it an important tool to control risk if the bad paths of the ‘T’ were taken.
- On the fixed income side, specifically because of the enormous amount of financial stimulus central banks have instigated, one should focus on short term and inflation protected bonds. However, as what we pointed out previously, we still prefer using a tactical approach to gain exposures to various segments in bonds. This is again due to our inability to forecast anything correctly.
Ultimately, when deciding what to do, one should always ask this question: “what if the prediction turns out to be false?”. Fortunately, even if the revisited New Normal turns out to be incorrect or largely unnecessary, the above asset allocation strategies and the proper risk management should not affect our portfolios’ performance seriously. For example, if it turns out that every economy goes to the bright and safe path in the T-junction, both strategic asset allocation and trend based tactical asset allocation should still deliver satisfactory results instead of being severely impacted by the nature of the strategy (for example, due to ill bets placed by a strategy).
Portfolio Performance Review
| Ticker/Portfolio Name | YTD Return** |
1Yr AR | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe | 10Yr AR | 10Yr Sharpe |
|---|---|---|---|---|---|---|---|---|
| AssetBuilder Model Portfolio 09 | 5.7% | 6.5% | 6.2% | 0.58 | 4.8% | 0.3 | ||
| Wealthfront Moderate Portfolio | 2.7% | 3.2% | 6.3% | 0.6 | 5.5% | 0.33 | ||
| Morningstar Ibbotson Balanced ETF Portfolio | 6.4% | 7.0% | 8.6% | 0.79 | 6.5% | 0.4 | ||
| MyPlanIQ Diversified Core Allocation ETF Plan Tactical Asset Allocation Moderate | 5.4% | 10.2% | 8.0% | 0.92 | 9.1% | 0.87 | 10.4% | 0.91 |
| MyPlanIQ Diversified Core Allocation ETF Plan Strategic Asset Allocation – Optimal Moderate | 4.0% | 5.9% | 8.6% | 0.83 | 7.6% | 0.49 | 8.2% | 0.57 |
| VBINX (Vanguard Balanced Index Inv) | 10.1% | 12.0% | 11.7% | 1.14 | 7.6% | 0.49 | 6.8% | 0.47 |
*: NOT annualized
**YTD: Year to Date
See the more detailed year by year comparison >>
The lackluster performance in emerging market stocks and commodities makes diversified global portfolios less competitive than the US only balance fund VBINX. However, longer term, the benefits of diversification will again deliver. On the other hand, we are happy to see that both our SAA – Optimal and TAA portfolios are doing well, compared with these portfolios.
Market Overview
Markets continued to play yo-yo: all stock markets improved a bit and showed signs of positive trends. Europe stocks recovered strongly, mostly due to the recent positive PMI report. However, nothing exceptionally strong to be written about.
For more detailed asset class trends, see 360° Market Overview.
We again copy our position statements (from previous newsletters):
Our position has not changed: We still maintain our cautious attitude to the recent stock market strength. Again, we have not seen any meaningful or substantial structural change in the U.S., European and emerging market economies. However, we will let markets sort this out and will try to take advantage over its irrational behavior if it is possible.
We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.
Latest Articles
- Permanent Portfolios Review
- Bucket Portfolio Stress Test
- Do Investors Deserve to Make Money?
- Is It Worth Betting on the ‘September Swoon’?
- Should you pay off your mortgage? (August 2013)
- 11 Best World Allocation Mutual Funds
- PIMCO’s El-Erian: New Normal with Stable Disequilibrium and T-Junction
- Power Fund a 529 Account Via ’5 Year Election’ in 2013
- The Q Ratio: Overvalued
- September 2, 2013: Momentum Investing and Current Market Review
- Come September: The Weakest Market Month in US Market History
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