Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite) portfolios are always rebalanced on the first trading day of a month.  For regular SAA and TAA portfolios, the next re-balance will be on Monday, February 3, 2020. You can also find the re-balance calendar for 2020 on ‘Dashboard‘ page once you log in. Please note that we are phasing out this rebalance calendar.  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.

Asset Outlook and Portfolio Strategies

We want to discuss our asset outlook and proper portfolio strategies in this first newsletter of the new year. 

Asset outlook

As usual, we discuss the recent asset trends in a big picture, or in a secular fashion. We have no strong ability and conviction one way or the other on what stocks and bonds will do in 2020 but we do believe a long term picture will help us to anchor our investment strategies. 
  • US stocks: investors have all celebrated a stellar 2019 for strong US stock returns. US economy did avoid a recession scare and managed to grow its GDP at 2.1% (Q3 figure). More importantly, unemployment rate remained all time low. Even though the trade wars, especially the US China one, probably affected economy somewhat, but they were not enough to cause serious damage. Wage growth also managed to beat CPI (inflation). However, as major US stock indexes such as S&P 500 have been in record territories and their valuation is now one of the highest in history (depending on what long term metrics one uses, but all are pointing to high overvaluation), the law of mean reversion is flashing a strong signal that in the coming decade or so, long term returns of US stocks will be extremely low. For a more detailed and excellent discussion, we again refer to Dr. Hussman’s commentary (we strongly suggest serious readers to go through this article). To quote: 

our estimate of prospective 12-year nominal total returns on a conventional portfolio mix (60% S&P 500, 30% Treasury bonds, 10% Treasury bills) fell to just 0.3% annually, the lowest level in history, breaching even the dismal prospects observed at the August 1929 pre-crash peak.

Though it’s arguable (and very unlikely) whether the long term returns 12 years or 10 years later will be exactly as predicted, we do believe that the likelihood of low or negative stocks returns in the coming decade will be very high. This is also corroborated with other long term metrics such as Shiller’s CAPE or Buffett’s Total Stock Market over GDP/GNP ratios (see, for example, this). 

What’s more, it’s very unlikely that in a future long period, stocks will remain relatively flat. History tells us that to get to flat or negative returns a decade later, it’s actually very likely that stocks will experience some big interim loss between -30% to -50% (using Hussman’s terminology, these are just run-of-the-mill figures). 

  • Foreign and emerging market stocks: international and emerging market stocks have lagged far behind US stocks for the past decade, this actually means they have better return prospect for the coming decade or so. Here is the GMO’s 7 year asset return forecasts

7-year is a relatively short time frame and the forecasts might be harder than for a longer period. However, it’s no doubt that emerging market stocks are relatively undervalued.

Keep in mind, of course, the above discussion is about a long term period and at the moment, in a year or so, it’s hard to pin point whether foreign and emerging market stocks will finally outperform the US. In fact, the fundamentals of US economy is actually more solid than those in the rest of the world. 

  • Bonds: investors can again celebrate the stellar 2019 returns in fixed income: 8.4% of Vanguard total bond index fund (VBMFX), 10.5% of our Schwab Total Return Bond portfolio and, 9.4% of our Schwab Total Return Bond Plus portfolio. However, in an ultra low interest rate environment, it’s becoming increasingly more and more difficult to gain a good return, especially for a buy and hold portfolio or fund (such as a bond index fund like VBMFX). For example, it’s an interesting read in a recent the Wall Street Journal article As Negative Yields Ebb, Making Money in Bonds Is Still a Slog. Intuitively, in a negative yield environment, it’s a mathematical certainty to lose money when bond yields remain flat or rise, regardless how little they rise. Similarly, in an ultra low rate environment such as the one in the US, it’s getting harder to make a positive return if rates rise, even just a bit. This is because the low interest yield will not be enough to compensate the loss of bond price when the rates rise. So bond investors are facing a more hostile and/or low return environment in the coming years. 

Jeffrey Gundlach, the famous Double Line total return bond fund manager, made an important observation on US bonds: as more and more companies utilized low rate environment (and the saved cash from tax cut) to borrow more to buy back their stocks and/or expand, many so called investment-grade bonds are susceptible to downgrade in a deteriorating economic situation (not yet happen). Such en-masse downgrade will wreak havoc bond markets and create a cascading effect that can seriously impact corporations’ borrowing ability and thus finance. 

To summarize, both stocks and bonds will be in some dismal situations in the coming decade or so, notwithstanding some near term rosy pictures. 

Portfolio strategies

We would like to emphasize while it’s extremely hard to forecast some short term (such as 1, 3 or even 5 years) returns for stocks and bonds, it becomes much more possible to predict future returns for a period as long as or longer than 10 years. The above discussion might have little to do with the coming year’s behavior of stocks and bonds and readers should not construe it as such either.  However, based on the above discussions, we can safely conclude that it’s very likely that a buy and hold strategic portfolio will not fare well in the coming decade, assuming not much allocation change along the way. What we strongly believe is that it’s becoming more and more important to adopt a risk managed tactical (or dynamic) portfolio strategy from now on, in a highly overvalued environment. One, for example, can see that our P Invest and Speculate, a portfolio (listed on Advanced Strategies) that turns tactical when stocks are overvalued can beat market indexes in a long term. We will have more quantitative data to support this in some future newsletters.  Though our Tactical Asset Allocation(TAA) hasn’t done as well as what we expect for the past 10 years, we want to reiterate that we have a high confidence that a TAA portfolio will achieve comparable or even better returns when a full market cycle completes (this means at the end of the next bear market). Furthermore, with the introduction of our Asset Allocation Composite (AAC), we feel more comfortable even for the near term as our AAC will only make drastic asset allocation change in a severe market downtrend (so it will capture more possible upsides if markets continue to advance).  Finally, we want to conclude this newsletter by pointing out that since we published a user’s emotional comment in our previous newsletter, we have received many encouraging emails from our long time readers. We will publish some of these comments in a future newsletter. 

Market overview

Investors continue to be optimistic since the beginning of the new year. Though the recent geopolitical and domestic political events might be a source of worry, markets mostly ignore them and continue to advance. However, it’s increasingly evident that markets are bubbly, even though as what we have learned from the recent past, this does not necessarily translate to an immediate market decline. On the other hand, small and mid cap stocks haven’t been able to breach their previous highs:  This could either support the argument that stocks still have some way to go (for small stocks at least) or the bearish argument that stocks haven’t been able to rise uniformly for so long (so they are more likely subject to a decline). We again have no strong feel one way or the other. What’s more important is that investors should stay on the course as planned and be risk conscious.  For more detailed asset trend scores, please refer to 360° Market Overview

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about 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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