July 10, 2017: Half Year Asset Trend Review

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Half Year Asset Trend Review

Financial markets in the first half of the year have been awfully calm. As we stated previously, implied volatility measured by CBOE VIX (an aggregate option implied volatilities of S&P 500 stocks) has been at some of lowest levels since 1990. This has occurred in the backdrop of elevated high stock valuation, the rising interest rate globally and the uncertain political environment of the first year of a new US president.

Let’s first look at the major asset trends in the first half:

Major asset trends

The six core assets have fared quite differently:

Six core asset performance (as of 7/7/2017):

Asset	YTD Return**	1Yr AR	3Yr AR	5Yr AR	10Yr AR
VTI (Vanguard Total Stock Market ETF)	8.5%	18.0%	8.7%	14.5%	7.1%
VEA (Vanguard FTSE Developed Markets ETF)	12.9%	20.7%	1.1%	8.9%
VWO (Vanguard FTSE Emerging Markets ETF)	13.7%	19.5%	-0.4%	3.2%	0.9%
VNQ (Vanguard REIT ETF)	1.1%	-2.9%	7.6%	8.3%	5.5%
DBC (PowerShares DB Commodity Tracking ETF)	-10.0%	-3.3%	-18.4%	-11.3%	-5.6%
BND (Vanguard Total Bond Market ETF)	1.3%	-2.2%	2.2%	1.6%	4.2%

The three major stock indices have performed quite comparably for the past one year while year to date, the international stocks (developed and emerging markets) have bettered the US stocks. The worst performer continues to be the commodity index (DBC): this benchmark has lost -5.6% for the past 10 years and the loss persisted in the first half of the year. The negative performance indicates that the normal price inflation has been very muted, even amid the interest rate increase. As usual, it’s negative performance points to a not so hot inflation environment, at least by the conventional standard: the Consumer Price Index (CPI) in the US rose 1.9% in the last 12 months in May 2017, below the 2% target level set by the Fed.

REITs also performed poorly. This is not unusual as the asset class always reacted to the Federal Reserve’s interest rate raise negatively. Furthermore, the valuation of this sector has also been high, similar to that of US stocks in general.

US bonds have performed well, given the Fed has been raising the interest rates. Given the muted inflation and the muted economic growth, one can argue that the interest rate increase will not affect bond price greatly. However, the argument can falter if inflation suddenly picks up pace and the Fed increases rates too much, among other factors.

In general, strategic portfolios have done well because they are closely linked to stock performance. Furthermore, tactical portfolios also performed as they in general correctly identified trending assets (both international, emerging market and US stocks). In fixed income portfolios, there were several under currents. Our municipal bond fund portfolios (see those listed on Brokerage Investors page) were deterred because of the rate scare in the end of 2016 and the first months of 2017. On the other hand, our taxable total return bond fund portfolios continued to outperform as they invested in funds that had over exposure in corporate investment grade and high yield bonds.

US stocks: growth vs. value

As it has been lately, in US stocks, growth stocks have bettered value stocks:

US Equity Style Trend

As of 07/07/2017

Description	Symbol	4 Weeks	13 Weeks	26 Weeks	52 Weeks	Trend Score
Russell Largecap Growth	IWF	-0.53%	4.86%	11.06%	17.59%	6.58%
Russell Midcap Growth	IWP	-0.36%	5.01%	8.87%	14.03%	5.48%
Russell Smallcap Growth	IWO	0.34%	6.18%	8.74%	21.14%	7.29%
Russell Largecap Index	IWB	-0.61%	2.88%	6.77%	15.6%	4.84%
Russell Midcap Indedx	IWR	-0.57%	2.59%	5.24%	13.74%	4.09%
Russell Smallcap Index	IWM	-0.77%	3.67%	3.84%	21.48%	5.58%
Russell Largecap Value	IWD	-0.69%	0.86%	2.55%	13.46%	3.09%
Russell Midcap Value	IWS	-0.87%	0.57%	2.23%	13.36%	2.86%
Russell Smallcap Value	IWN	-1.75%	1.46%	-0.55%	21.95%	4.12%

However, the (out)performance of growth stocks continues to be concentrated in technology stocks, especially those large internet stocks. The acronyms of FANG (Facebook, Amazon, Netflix and Google) or FAAMG (Facebook, Amazon, Apple, Microsoft and Google) are akin to Nifty Fifty stocks in early 1970s. One day this will surely end, but for now, markets are still driven higher by these stocks.

Though we are also fascinated and convinced that the internet/mobile connected technology has finally taken a shape in the everyday’s life (and economy), the underlying economy and financial markets will not escape from their fundamental rules: profit margin will reverse to mean and valuation will reverse to mean at some point. Investors should not be fooled by the same old argument ‘this time is different’. We have seen this movie in 2000 and before.

Fixed income bonds

As interest rates are increasing, bonds both long and short end have been hurt. This is again not surprising as this is exactly the environment where the interest rate risk (one of the two major risks in bond investments, the other is credit risk) has reared its head. Buoyed by the positive equity (stock) environment, investors are flocking to corporate bonds: investment grade, high yield bonds and emerging market bonds — the risky bond segments. Similarly, for municipal bonds, low grade high yield ones are still doing well, even when other segments are showing weakness. For more details, please see 360° Market Overview.

As stated elsewhere, we advocate active investment in fixed income. Even though our fixed income bond portfolios have benefited from investing in those funds that have over exposure to the risky spectrum of bond segments, our portfolios are fully prepared to de-risk when markets are in a dire situation.

Market Overview

Last week, stocks finally experienced some weakness. However, up till now, US broad base stock indices are stubbornly stuck to their record levels in a generally seasonal weak period. On the other hand, based on the following chart from StockCharts, stocks in S&P 500 that were above their 200 moving averages fell to 71.4, it’s certainly not uniform at all while S&P 500 index is just one percent from its all time high.

Though it’s hard to see the US economy (or other major global economies) is near recession, we remind our readers that stocks do not need to rely on economic weakness to retreat. Many factors can contribute to their weakness. Again, in the current high stock valuation and hostile interest rate environment, investors should exercise extra caution and better risk management while sticking to their sound investment plans.

For more detailed asset trend scores, please refer to 360° Market Overview.

Now that the Trump administration is officially sworn in, the new president is facing the reality to deliver his many promises to make substantial changes. As the nation is posed to invest, the most important factor to watch is how productive the investments will be. Simply put, productive investments will result in better return on investment (ROI), tangibly or intangibly. They should also increase productivity that in turns will improve our standard of living. Capital misallocation can result in a higher growth but might not improve the real standard of living, which is the ultimate goal of economic activities. Whether the new president can truly achieve this goal is still yet to be seen. One thing is certain: we will see more market volatilities.

In terms of investments, U.S. stock valuation is at a historically high level. It is thus not a good time to take excessive risk. However, we remain optimistic on U.S. economy in the long term and believe much better investment opportunities will arise in the future.

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.

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