The Book of Matthew foresees that the last will be first, and the first will be last. Investors will recognize the prophecy as the restless rotation in the realm of asset classes—a concept that even the blind can see in this year's market’s action.
Indeed, two weeks ago in this space I noted that it doesn’t get much better than for US stocks. As it turned out, it doesn’t, or at least it hasn’t so far. The hefty 22% year-to-date increase in our proxy ETF for domestic stocks has subsequently retreated to less than 18%. That’s still a handsome advance, of course, but the gravitational force of mean reversion has intervened once more as a reminder that trees (still) don't grow to the sky.
Unfortunately for investors with diversified portfolios, the laggards aren’t yet rebounding from the bout of red ink in a meaningful way. Emerging market equities, to take the leading example, are sinking again, slipping more than 12% on a year-to-date basis through August 19, or near the lowest point so far this year. To be fair, there's also some improvement to recognize. Commodities generally have recently regained a portion of performance ground previously lost this year. Meantime, foreign high-yield junk bonds have done even better, rallying sharply for the better part of the past two months and posting a rare bit of positive performance for 2013's year-to-date ledger through yesterday.
Nonetheless, the overall trend of late has been unmistakably bearish. Should we be surprised? Perhaps, although the fact that the Global Market Index (a passive, unmanaged, market-weighted mix of all the major asset classes) was posting a healthy rise in 2013 through the end of last month should have at least tempered expectations and inspired thoughts of rebalancing.
Hindsight is 20/20, of course. But does history repeat? Yes, to a degree, although it’s a messy affair, particularly in the short run. But ask yourself a simple question: Do you expect the structure of returns, as shown in the chart below, to remain etched in stone?
The chart above is a recap of performance of an equally weighted portfolio of all the major asset classes in terms of relative changes to the asset allocation. Using a start date of Dec. 31, 2012 for the equal weights, the chart depicts the current portfolio composition in context with the range of allocations year to date. The strategy for this illustration is equally weighting everything and letting the unmanaged allocations fluctuate freely through yesterday’s close (August 19).
Next, here's a graphical review of how the major asset classes have performed this year (based on daily closing prices) in relative terms through August 19, 2013. In the next chart below, all the ETF prices have been reset to 100 as of Dec. 31, 2012:
Yes, it all looks rather ugly at the moment. The tidy gains of the spring have given way to lesser performance and/or losses. It’s anyone’s guess when we’ll see a more encouraging trend. But at least one aspect of managing asset allocation remains clear: being a contrarian in real time is the toughest job in finance. It’s also one of the few paths that leads to the promised land of satisfactory results through time. The financial gods work in mysterious ways.