Home/Blog/Investing Insights/Time to tweak your asset allocation?

Time to tweak your asset allocation?

13 July 2016 in Investing Insights

Stock markets have more than rebounded from Brexit as stocks rallied to record highs on the back of a strong June jobs report. But take note investors: you are likely not out of the woods yet.

Talk of an imminent recession has been heating up, and the consequences of U.K.’s divorce from the EU have yet to play out. This week, former home secretary Theresa May succeeds David Cameron as Britain’s prime minister and one of her first to-dos will be to decide when to formally invoke Britain’s withdrawal from the EU under Article 50 of the EU’s Lisbon Treaty. Once this is triggered, the U.K. will have two years to negotiate the terms of its exit.

Given these uncertainties, investors may want to take steps to fortify their portfolios by first answering a couple of key questions:

  • Is it a good time to adjust domestic and international exposure in your portfolio?
  • Are diversifiers like bonds suitable in ultra-low interest rate environments?

How much longer can U.S. equities continue their run?
Determining how to weight different asset classes including stocks and bonds can get tricky in times like this but assessing the changed environment is what disciplined investors do, contrary to the advice of certain passive-investing advocates.

The S&P 500 has been a stellar performer over the last couple of years, breaking away from international [EFA] and emerging market stocks [EEM].

Click image to enlarge.

SPY EEM EFA

U.S. large caps [SPY] have outpaced international stocks [EFA] since 2010 and emerging market stocks [EEM] since the end of 2013. Source: Google Finance

 But demand for U.S. large caps may start to weaken, since many of these companies make a significant portion of their sales overseas and investors risk appetites could wane.

This calls into question whether it’s a good time to increase exposure to international and emerging markets. Typically, there is a low correlation between U.S. and foreign equities when markets are rising or flat, which can provide diversification benefits. But the correlation tends to rise significantly during dicey times like Brexit when multiple global equity markets tumble alongside the U.S. on a larger scale.

When the Brexit referendum results were tallied, the S&P 500 proceeded to fall 3.6 percent, the Euro Stoxx 600 dropped 7 percent, the FTSE 250 was down 7.2 percent and the Nikkei 225 fell 7.9 percent.[1] A week after Brexit, the S&P 500 rebounded to reach new all-time highs while international markets still haven’t reached their pre-Brexit levels.

Even if you aren’t convinced there are enough diversification benefits of international exposure for your portfolio, it’s worth considering the potentially favorable valuations. Earlier this year, several influential fund managers came out saying emerging market assets are undervalued.[2]  Although the performance of emerging market and international stocks has been lagging behind the U.S., given SPY’s run-up, international and emerging market stocks look cheap by comparison. SPY is trading at 18x, compared to EEM’s 12x and EFA’s 15x as of July 9th, 2016.[3]

Additionally, roughly 75 percent of the world’s publicly traded companies are located outside the U.S. making for a large pool of securities to choose from.[4] Some sectors that have been up post-Brexit and could continue to do well relative to others include consumer goods, pharmaceuticals, big oil, liquors and tobacco companies. In addition, UK companies like food and beverage companies that sell mostly overseas shouldn’t be as affected by the falling British pound compared to firms with consumers primarily in the UK. On the other hand, a few sectors that have been on the losing end post-Brexit include British and European banks, financials, insurers, airlines and real estate.[5]

Lastly, history seems to suggest that international stocks can be a good diversifier.

Click to enlarge

internationalvus stocks

Historically, U.S. and international stock performance tend to deviate due to currency and political risk. Source: Russell Investment Group, FactSet, as of June 15, 2015 

Thinking about your stock and bond asset allocation?
One common asset allocation approach many investors choose to take during uncertain economic times is to shift their portfolio weightings from stocks to less risky assets like bonds. This trend is already taking place post-Brexit and government bonds have hit all-time lows.

 As negative sentiment towards U.K. investments has risen in recent weeks, many investors have been eagerly buying U.S. government debt, which is generally considered a safe asset class.[6] As a result of this surge in demand, 10-year U.S. treasury yields have dropped significantly and reached a new record low of 1.34 percent on July 6, 2016.

Click image to enlarge

10 year Treasuries

Ten-year Treasuries have fallen from 1.85 percent at the start of June to a record low of 1.34 percent on July 6, 2016. Source: Yahoo Finance

It is not a huge surprise that yields have fallen recently, but whether or not a recession is imminent – historically, recession concerns send yields falling – is yet to be determined.

The U.S. economy is still believed to be relatively sturdy even though U.S. Treasury yield curve has flattened. It’s worth noting that despite close to record low 10-year bond yields, U.S. government bond yields still remain much higher than the bond yields of many other large economies even after the recent drops.

For example, Germany’s 10-year government bond yields recently slipped into negative territory, dropping to a record low of -.0176 percent on July 6th. On the same day, Japan’s 10-year government bond yields also hit a record low of -0.275 percent and their 20-year government bonds went negative for the first time as well, falling as low as -0.005 percent.[7] Swiss government bond yields have also been falling and have gone negative all the way out to 50 years.[8]

Can these types of government bonds be perceived as safe assets? Only time will tell, but the influx of domestic and foreign money buying up government debt in the U.S., Germany, Japan and Switzerland suggest low consumer confidence and continued low or negative levels of inflation and stagnant economic growth for many years to come. By the time a country enters negative interest rate territory, it may be too late for equity investors. Conventionally, an increase in negative interest rate policies around the world signal investors to get more defensive and deflation becomes even more difficult to combat.

When stocks go down, do bonds always go up?
Stocks and bonds have historically had an inverse relationship or negative correlation to each other, meaning they tend to move in different directions. This relationship has been in flux since the late 1990s, however, with the correlation moving back and forth between positive, negative and zero. In other words, when determining your portfolio allocation you can’t make a blanket assumption that bonds will always go up if stocks go down.

Click image to enlarge.

bond stock correlation[1]

Correlation breaks between stocks and bonds can occur with changes in the direction of the U.S. dollar and are highly sensitive to Fed policy news. Source: Seeking Alpha

Some analysts speculate that in addition to sensitivity around expected Fed policy changes (low expectations for a rate hike for the rest of the year), the correlation between stocks and bonds has a tendency to be positive in ultra-low interest rate environments and negative in times of high rates.[9]

Stay calm and carry on
There’s certainly a lot to consider when it comes to your portfolio’s asset allocation and the post-Brexit environment adds another layer of complexity. At the end of the day, don’t lose sight of your long-term investment goals and do your best to stay abreast of the markets both domestically and abroad.

 

Need help getting started? Motif Investing is built for how you think and work. Sign up for an account today and act on a trend in a single click and easily customize holdings as you get new information and insights.

 

[1] Mackenzie, Michael, Eric Platt, “How global markets are reacting to UK’s Brexit vote, Financial Times, June 24, 2016.

[2] http://www.bloomberg.com/news/articles/2016-02-24/pimco-adviser-sees-the-trade-of-a-decade-in-emerging-markets

[3] Yahoo staff, “SPDR S&P 500 ETF Trust (SPY),” “iShares, Inc. – iShares MSCI Emerging Markets ETF (EEM),“ “iShares Trust – iShares MSCI EAFE ETF (EFA),” Yahoo Finance, July 9, 2016.

[4] Fidelity staff, “Why you may need more international stock,” Fidelity, November 18, 2015.

[5] Zekaria, Simon, “Stock-market winners and losers after Brexit vote,” The Wall Street Journal, June 27, 2016.

[6] Rabouin, Dion, “Sterling slumps, Treasury yields hit record low as uncertainty persists,” Reuters, July 5, 2016.

[7] Kachi, Hiroyuki, Kosaku Narioka, “Japan’s 20-year government bond yield goes negative for first time,” The Wall Street Journal, July 6, 2016.

[8] Rabouin, Dion, “Sterling slumps, Treasury yields hit record low as uncertainty persists,” Reuters, July 5, 2016.

[9] Kieran, Kaitlyn, “Why aren’t stocks and bonds moving in opposite directions,” The Wall Street Journal, July 25, 2013.

Investing in securities involves risks, you should be aware of prior to making an investment decision, including the possible loss of principal. An investment in individual stocks, or a collection of stocks focused on a particular theme or idea, such as a motif, may be subject to increased risk of price fluctuation over more diversified holdings due to adverse developments which can affect a particular industry or sector. Investments in ETFs can include those with a narrow or targeted investment strategy and can be subject to similar sector risks than more broadly diversified investments. Motif makes no representation regarding the suitability of a particular investment or investment strategy. You are responsible for all investment decisions you make including understanding the risks involved with your investment strategy.

Performance returns, including 1-month Return/Return Since Inception/1-year returns indicate the performance of this particular motif over that stated period of time as of the date provided. Performance is quoted for informational purposes only, however, there is no guarantee those returns will continue. See how we calculate returns.

International investments involve additional risks you should be aware of, which include differences in financial accounting standards, currency fluctuations, political instability, foreign taxes and regulations, news that can trigger volatile conditions, and the potential for illiquid markets.

Fixed income investments are subject to various unique risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Fixed income securities are subject to increased loss of principal during periods of rising interest rates.

(1) For additional information regarding the risks associated with leveraged and inverse ETFs, please access the Support page to review the FINRA Investor Alert on Leveraged and Inverse ETF’s Risks (http://www.finra.org/investors/protectyourself/investoralerts/mutualfunds/p119778), and SEC Investor Education: ETFs (http://www.sec.gov/investor/alerts/etfs.pdf)

 

  1. JASHWANT SHAH
    8 Mar at 8:33 am

    Do you offer IRAs?
    If yes, I want to transfer my wife’s and my IRAs.
    I need MRDs in both IRAs. Also we do cherity from our MRDs. Will you permit?
    What about primary and secondary beneficiaries? Will you handle?

    Reply
    • Motif
      24 Mar at 9:45 am

      Hi Jashwant. Yes, we do offer IRAs and yes we do allow customers to direct their RMDs to charity. You can choose to name a primary and secondary beneficiary during the account opening process.

      Reply

*