Are Markets Returning To 'Normal' Behavior?

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Includes: ABRZX
by: Invesco US

Summary

The Invesco Global Asset Allocation team sees three “typical” characteristics that have returned to the markets over the last few months.

Among those characteristics: Diversification is in demand again.

When there is greater disparity in the markets, there is greater scope for asset allocation strategies to help investors stay prepared.

2016 hasn't been kind to stocks, but other assets are providing opportunities

By Scott Wolle, Portfolio Manager. Posted on Expert Investment Views: Invesco US Blog.

The Invesco Global Asset Allocation team doesn't consider double-digit declines in equity markets to be normal. However, we do see three "typical" characteristics that have returned to the markets over the last few months - characteristics that we believe bode well for a global asset allocation approach.

1. Diversification is in demand again. Historically, owning a wide set of assets has, on balance, been a smart strategy in both good times and bad. But the last few years - like the late '90s dot.com era - have largely been an environment where US stocks have consistently outperformed and diversification has detracted from returns. Recent months have looked more typical with Treasuries, and even certain commodities, providing decent returns (see chart 1). Today, many assets remain far more attractively valued than the S&P 500 Index, in our opinion, meaning that when the equity market eventually rebounds, it may not prove to be such a dominant source of return.

Year-to-date, precious metals and long Treasuries have provided meaningful returns

precious metals and long Treasuries

Sources: Datastream and Invesco analysis. Performance from Dec. 31, 2015, to Feb. 9, 2016. Precious metals: S&P GSCI Precious Metals Index. Long Treasuries: Barclays US Treasury 20+ Year Index. T-Bills: Barclays 3-Month T-Bill Index. Emerging debt: JPMorgan EMBI Global Composite Index. Industrial metals: S&P GSCI Industrial Metals Index. Agriculture: S&P GSCI Agriculture Index. High yield: Barclays US Corporate High Yield 2% Issuer Capped Index. Emerging: MSCI Emerging Markets Index. US large cap: S&P 500 Index. International developed: MSCI EAFE Index. US small cap: Russell 2000 Index. Energy: S&P GSCI Energy Index. Past performance cannot guarantee future results. An investment cannot be made in an index.

2. Something's doing well. This is an important variation on the first observation. In 2015, no asset among a broad set of stocks, bonds, and commodities returned more than 2%. That's the first time in at least 40 years that has been the case (see chart 2.) So far in 2016, many assets have fallen, but a few have offered double-digit gains, as noted in the first point. When there is greater disparity in the markets, there is greater scope for asset allocation strategies to help investors stay prepared.

In 2015, no asset class returned more than 2%

2015 asset class returns

Sources: Datastream and Invesco analysis. Performance from Dec. 31, 2014, to Dec. 31, 2015. Precious metals: S&P GSCI Precious Metals Index. Long Treasuries: Barclays US Treasury 20+ Year Index. T-Bills: Barclays 3-Month T-Bill Index. Emerging debt: JPMorgan EMBI Global Composite Index. Industrial metals: S&P GSCI Industrial Metals Index. Agriculture: S&P GSCI Agriculture Index. High yield: Barclays US Corporate High Yield 2% Issuer Capped Index. Emerging: MSCI Emerging Markets Index. US large cap: S&P 500 Index. International developed: MSCI EAFE Index. US small cap: Russell 2000 Index. Energy: S&P GSCI Energy Index.

3. Volatility has reverted to more normal levels. We all became spoiled with equity volatility below 15%. But it's far more typical to see volatility in the 15% to 20% range (see chart 3). Even when the current bout of fear subsides, volatility seems unlikely to return to the exceedingly low levels of 2013 and 2014 as we see interest rates begin to normalize from their historically low levels. The transition from central bank-driven markets - while perhaps necessary - was never likely to be terribly pleasant, and the resumption of higher volatility was inevitable, in our view.

Historically, it's typical for equity volatility to be more than 15%

equity volatility

Sources: Datastream and Invesco analysis. Performance from Jan. 31, 1986, to Feb. 9, 2016. Equity market volatility represented by the CBOE Volatility Index® (VIX®).

Our approach to asset allocation

Many investors rely on a 60% stock/40% bond portfolio to provide both offense and defense during volatile markets. However, that type of portfolio may not be as durable as investors believe - it's heavily exposed to the risks of the equity market, which, in our view, limits its effectiveness in different economic environments.

In contrast, Invesco Balanced-Risk Allocation Fund seeks to balance its risks between stocks, government bonds and commodities1- each of which has historically outperformed in different types of environments. At the same time, we make monthly tactical adjustments that are designed to capitalize on timely market opportunities in these asset classes.

To learn more about my team's approach, read my previous blog: Risk Parity: It's About Preparation, Not Predictions. You can also find more information here for Invesco Balanced-Risk Allocation Fund (MUTF:ABRZX).

Important information

1. Under normal conditions, the strategy invests in derivatives and other financially-linked instruments whose performance is expected to correspond to U.S. and international fixed income, equity and commodity markets. However, the performance of the asset classes cannot be guaranteed.

The S&P GSCI Precious Metals Index is a benchmark for investment performance in the precious metals market.

The Barclays US Treasury 20+ Year Index is an unmanaged index considered representative of US Treasury bonds with maturities longer than 20 years.

The Barclays 3-Month T-Bill Index is an unmanaged index considered representative of US Treasury bills with maturities of three months.

The JPMorgan EMBI Global Composite Index measures the performance of emerging markets bonds.

The S&P GSCI Industrial Metals Index is a benchmark for investment performance in the industrial metals market.

The S&P GSCI Agriculture Index is a benchmark for investment performance in the agriculture market.

The Barclays US Corporate High Yield 2% Issuer Capped Index is an unmanaged index that covers US corporate, fixed-rate, noninvestment-grade debt with at least one year to maturity and $150 million in par outstanding.

The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.

The S&P 500® Index is an unmanaged index considered representative of the US stock market.

The MSCI EAFE Index is an unmanaged index considered representative of stocks of Europe, Australasia and the Far East.

The Russell 2000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of small-cap stocks.

The S&P GSCI Energy Index is a benchmark for investment performance in the energy market.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. VIX is the ticker symbol for the Chicago Board Options Exchange (NASDAQ:CBOE) Volatility Index, which shows the market's expectation of 30-day volatility.

Stock and other equity securities values fluctuate in response to activities specific to the company as well as general market, economic and political conditions.

Fixed-income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer's credit rating.

Commodities may subject an investor to greater volatility than traditional securities such as stocks and bonds and can fluctuate significantly based on weather, political, tax, and other regulatory and market developments.

The information provided is for educational purposes only and does not constitute a recommendation of the suitability of any investment strategy for a particular investor. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state tax laws are complex and constantly changing. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the authors, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

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All data provided by Invesco unless otherwise noted.

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Are markets returning to 'normal' behavior? by Invesco US Blog