We have monitored this asset closely since my favorable July-2013 article: the price is currently about the same as it was in July, while it paid two attractive quarterly dividends.

To achieve higher yield, mortgage REITs finance a portion of their investments by debt in addition to equity. The largest ETF based on mortgage REITs is the iShares Mortgage REIT Capped ETF, with $1.2 billion in assets. Annaly (NLY) (~15%) and American Capital Agency (AGNC) (~12%)

]]>Mortgage real estate investment trusts (mREITs) such as Annaly Capital Management (NLY) and American Capital Agency (AGNC) combine characteristics of both equities (with Beta of about 0.5 currently) and fixed income. Assuming no price appreciation, mREITs' double-digit dividend yields exceed our firm's expected return for U.S. equities that was recently reduced, and far exceed other fixed-income alternatives. **I think the**** iShares Mortgage REIT Capped ETF (REM) currently presents an attractive risk-return opportunity.**

We have monitored this asset closely since my favorable July-2013 article: the price is currently about the same as it was in July, while it paid two attractive quarterly dividends.

To achieve higher yield, mortgage REITs finance a portion of their investments by debt in addition to equity. The largest ETF based on mortgage REITs is the iShares Mortgage REIT Capped ETF, with $1.2 billion in assets. Annaly (NLY) (~15%) and American Capital Agency (AGNC) (~12%)

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**Emerging-Market Currency Exchange Rates vs. USD**

Argentine Peso, Brazilian Real, Indian Rupee, Turkish Lira

*(click to enlarge)*

Sources: YCharts, Model Capital Management LLC

**It Started with EM Currencies**

Emerging-market currencies were in turmoil last week - a reminder that currency is a significant part of risk when investing in emerging markets. Argentina's

]]>Contagion from emerging markets spread to developed market equities in the latter part of January, with the S&P 500 (SPY) down 5.3% from its peak on Jan 15. In the midst of the Fed's tapering that will reduce access to cheap liquidity, many investment managers moved to a risk-off mode, reducing their most risky positions. In this article, I argue that based on fundamentals, the sell-off may be justified in the cases of EM and Japan. In the U.S., on the other hand, long-term fundamentals have improved, and U.S. equities are becoming quite attractive at these lower levels.

**Emerging-Market Currency Exchange Rates vs. USD**

Argentine Peso, Brazilian Real, Indian Rupee, Turkish Lira

*(click to enlarge)*

Sources: YCharts, Model Capital Management LLC

**It Started with EM Currencies**

Emerging-market currencies were in turmoil last week - a reminder that currency is a significant part of risk when investing in emerging markets. Argentina's

Complete Story »]]>

It's the time of year when investors and investment managers alike plan on how to position their portfolios for success in 2014. Part of the value that wealth managers deliver to clients is advising them on proper asset allocation. In fact, it's a very important part - research has shown that about 90% of return and risk for a balanced stock-and-bond portfolio comes from asset allocation^{1}.

In this series, I focus on the biggest asset allocation decision - equities vs. fixed income. A typical recommended allocation for individuals who are between 45 and 60 years old is 60% stocks, 40% bonds. Most pension plans and endowments also hold a similar 60/40 aggregate asset mix. This Part 1 article covers mainly fixed income.

**Not so boring in the last 30 years!**

Let us start

**This is Part 1 of the series:** **Asset Allocation: What's Right for 2014 and Beyond**

It's the time of year when investors and investment managers alike plan on how to position their portfolios for success in 2014. Part of the value that wealth managers deliver to clients is advising them on proper asset allocation. In fact, it's a very important part - research has shown that about 90% of return and risk for a balanced stock-and-bond portfolio comes from asset allocation^{1}.

In this series, I focus on the biggest asset allocation decision - equities vs. fixed income. A typical recommended allocation for individuals who are between 45 and 60 years old is 60% stocks, 40% bonds. Most pension plans and endowments also hold a similar 60/40 aggregate asset mix. This Part 1 article covers mainly fixed income.

**Not so boring in the last 30 years!**

Let us start

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The Financial sector was hit hard by JPMorgan's (JPM) surprise quarterly loss of -$0.17 per share after it took a $7.2 billion ($1.85 per share) charge for legal reserves and expenses. This brought the sector from the expected leader for Q3 EPS growth (expected 9% YoY on Sep 30) to being the second-worst sector, at 0.2% (see chart below).

JPMorgan's loss has a profound effect not only on the Financials but on the overall index Q3 earnings as well. In fact, excluding JPMorgan, the rest of the sector exhibited very healthy earnings growth, at 16% YoY, led by Bank of America (BAC) and Morgan Stanley (MS). The overall **earnings growth for the S&P**

The Q3-2013 earnings season is essentially over, with over 90% of the S&P 500 (SPY) companies having reported their results. **Earnings growth rate, at 3.5%,** continues at the slow pace of the past four quarters.

The Financial sector was hit hard by JPMorgan's (JPM) surprise quarterly loss of -$0.17 per share after it took a $7.2 billion ($1.85 per share) charge for legal reserves and expenses. This brought the sector from the expected leader for Q3 EPS growth (expected 9% YoY on Sep 30) to being the second-worst sector, at 0.2% (see chart below).

JPMorgan's loss has a profound effect not only on the Financials but on the overall index Q3 earnings as well. In fact, excluding JPMorgan, the rest of the sector exhibited very healthy earnings growth, at 16% YoY, led by Bank of America (BAC) and Morgan Stanley (MS). The overall **earnings growth for the S&P**

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Investors bid oil up above $100 in the July-September period due to concerns about Syria using chemical weapons and the potential U.S. military strike against the Assad regime. These concerns have now receded, and international inspectors confirmed on October 31st that Syria has destroyed all of its declared chemical weapons production facilities, meeting the first significant deadline in the process. With the Middle Eastern "premium" out of the picture, fundamentals will now determine the new price level for oil -

Demand for energy resources has been soft in recent years due to

]]>Fundamentals for crude oil price have been fairly weak for a while, as we've highlighted here on May 15. This short article updates developments that occurred since May - the Middle East premium that drove the price of the WTI contract above $100, which is now removed, and the new "carbon bubble" perspective advocated by Al Gore.

Investors bid oil up above $100 in the July-September period due to concerns about Syria using chemical weapons and the potential U.S. military strike against the Assad regime. These concerns have now receded, and international inspectors confirmed on October 31st that Syria has destroyed all of its declared chemical weapons production facilities, meeting the first significant deadline in the process. With the Middle Eastern "premium" out of the picture, fundamentals will now determine the new price level for oil -

Demand for energy resources has been soft in recent years due to

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**3-Year Price Performance: REIT Index ETFs Vanguard REIT Index (VNQ), IYR (IYR), Mortgage REIT ETF (REM)**

*(click to enlarge)*

ETFs that invest in diversified portfolios of REITs are efficient instruments for investing in this asset class. U.S. REIT index ETFs invest in an index of "traditional" REITs, which in turn invest in diversified U.S. real estate (including residential, commercial, and industrial properties). By far the largest among them is the Vanguard REIT Index, with $36 billion in assets. It is also the most cost-effective, with an expense ratio of only 0.10%. Other index

]]>The upshift in interest rates brought about a new set of return-risk asset class opportunities. Real estate investment trusts (REITs) were hit hard by rising interest rates. Regular U.S. REITs dropped by about 9% in May-June, and mortgage REITs sold off by 20%. Is the selloff justified by higher interest rates, or is this a buying opportunity?

*(click to enlarge)*

ETFs that invest in diversified portfolios of REITs are efficient instruments for investing in this asset class. U.S. REIT index ETFs invest in an index of "traditional" REITs, which in turn invest in diversified U.S. real estate (including residential, commercial, and industrial properties). By far the largest among them is the Vanguard REIT Index, with $36 billion in assets. It is also the most cost-effective, with an expense ratio of only 0.10%. Other index

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The world supply capacity growth, however, has been below demand growth in 2010-11, making for a tight market and contributing to elevated prices.

Sources: IEA**,** Model Capital Management LLC

Two pieces of information just surfaced recently that, in our view, are critical pieces of the puzzle for future crude oil prices and other energy resources.

**North American Supply Shock**

]]>The

Demand for energy resources has been soft in recent years, due to economic problems in much of the developed world. This brought world demand growth for crude oil negative in 2008 and 2009 (see chart below). In addition, the general drive toward energy efficiency has been slow but steady, including more natural-gas power plants, efficient appliances, fuel-efficient cars, and 100% electric cars. Sluggish demand was interrupted by a spike in demand from emerging markets (in particular, China) in 2010, but that reversed in 2011-12 as China slowed down.

The world supply capacity growth, however, has been below demand growth in 2010-11, making for a tight market and contributing to elevated prices.

Sources: IEA**,** Model Capital Management LLC

Two pieces of information just surfaced recently that, in our view, are critical pieces of the puzzle for future crude oil prices and other energy resources.

**North American Supply Shock**

The

Complete Story »]]>

Rather, being synonymous with stability, gold has seen investment demand as a hedge against "really bad things" happening. The debt bubble bursting in 2007 created a severe financial crisis in the U.S. and in Europe, and governments coped with the crisis by flooding their financial systems with unprecedented amounts of liquidity. Naturally, people were concerned that all this newly-created money might put fiat currencies

]]>Gold (GLD) has become a staple in many investor portfolios. What are the reasons people want to own gold? As a real asset, gold is sometimes viewed as protection against inflation. However, since the 1970s, the price of gold has been a poor hedge against inflation - the correlation between the CPI and gold price is close to zero. The rally in gold of roughly 140% over five years from 2007 to 2011 had nothing to do with inflation, which was very low during this period.

Rather, being synonymous with stability, gold has seen investment demand as a hedge against "really bad things" happening. The debt bubble bursting in 2007 created a severe financial crisis in the U.S. and in Europe, and governments coped with the crisis by flooding their financial systems with unprecedented amounts of liquidity. Naturally, people were concerned that all this newly-created money might put fiat currencies

Complete Story »]]>

A low positive return forecast for the S&P, between 0% and 2% (which doesn't happen often), means that our Tactical Strategy allocations match their balanced benchmark. Low expected returns on both stocks and bonds don't justify taking risk over benchmark in either asset class. Accordingly, **we are changing the stocks-bonds allocation in our U.S. Tactical ETF Strategies to 60% stocks, 40% bonds.**

The equity rally continued in full force so far in March, with the S&P 500 adding another 3% for a year-to-date return of 6.7%, and 10.2% from the end of November of 2012 - the month of the last moderate downturn in the market. Having been positive since June of 2012, our model produced a very high return forecast in November (19.2%), which we

]]>Our PAR Model six month forecast for the S&P 500 fell to 0.4% at the end of March, from 5.5% just a month ago.

A low positive return forecast for the S&P, between 0% and 2% (which doesn't happen often), means that our Tactical Strategy allocations match their balanced benchmark. Low expected returns on both stocks and bonds don't justify taking risk over benchmark in either asset class. Accordingly, **we are changing the stocks-bonds allocation in our U.S. Tactical ETF Strategies to 60% stocks, 40% bonds.**

The equity rally continued in full force so far in March, with the S&P 500 adding another 3% for a year-to-date return of 6.7%, and 10.2% from the end of November of 2012 - the month of the last moderate downturn in the market. Having been positive since June of 2012, our model produced a very high return forecast in November (19.2%), which we

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The PAR Model is the proprietary factor model that we use to forecast equity returns over a six-month period. The model is based on a dynamic multi-factor regression of S&P 500 returns over economic, valuation, and market variables. Factors are chosen automatically each month based on their statistical significance from the initial set of 22 factors that have proven to be significant over time. Forecasts are revised twice a month.

The model provides the answers that tactical asset allocation

]]>The six-month S&P 500 (SPY) return forecast by our Performance Analytics Return Model (PAR Model) increased once again this month, to 19.2%. This is only the second time in a decade of backtesting that the model gave such a high return forecast. The last time this happened before was in 1H-2009. We consider this to be a tremendous buying opportunity that comes across only a couple of times in a decade.

The PAR Model is the proprietary factor model that we use to forecast equity returns over a six-month period. The model is based on a dynamic multi-factor regression of S&P 500 returns over economic, valuation, and market variables. Factors are chosen automatically each month based on their statistical significance from the initial set of 22 factors that have proven to be significant over time. Forecasts are revised twice a month.

The model provides the answers that tactical asset allocation

Complete Story »]]>

]]>"Portfolio returns in excess of an index can be achieved through active investment management in two ways: security selection, and active (or tactical) asset allocation. Research shows that about 90% of a typical balanced stock-bond portfolio risk and return comes from Policy asset allocation - see Brinson et.al. (1986, 1991), Ibbotson & Kaplan (2000). Clearly, potential for adding value through actively managing asset allocation is greater than from active security selection. However, while active security selection is widely practiced, tactical asset allocation (TAA) has been largely overlooked or out of favor. Here, we discuss some of the reasons for this, and describe the process that should be followed in order to successfully perform TAA.

An interesting new white paper written by Alexander Melnikov, PhD., Professor of Mathematical Finance at the University of Alberta speaks to the relationship between alpha and "information coefficient" (IC), as defined by Grinold and Kahn:

"Portfolio returns in excess of an index can be achieved through active investment management in two ways: security selection, and active (or tactical) asset allocation. Research shows that about 90% of a typical balanced stock-bond portfolio risk and return comes from Policy asset allocation - see Brinson et.al. (1986, 1991), Ibbotson & Kaplan (2000). Clearly, potential for adding value through actively managing asset allocation is greater than from active security selection. However, while active security selection is widely practiced, tactical asset allocation (TAA) has been largely overlooked or out of favor. Here, we discuss some of the reasons for this, and describe the process that should be followed in order to successfully perform TAA.

Complete Story »]]>

The PAR Model is a factor model that estimates expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of S&P 500 returns over economic, valuation, and market variables. Factors are chosen automatically each month based on their statistical significance from the initial set of 22 factors that have proven to be significant over time.

Significant Factors - Summary

**Valuation:** **Net Positive**

The effect of valuation factors on the model's expected return is net positive, though slightly lower due to the rally in equities so far in August. The P/E ratio continues to extend a significant positive contribution at 0.7 standard deviations ("SD" in this report), followed by the Price to Book ratio (0.2 SD), and partly offset by the

]]>Our model continues to forecast positive 6-month expected return for the S&P 500, currently 4.3%. Accordingly, asset allocation recommendation is still Overweight public equities.

The PAR Model is a factor model that estimates expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of S&P 500 returns over economic, valuation, and market variables. Factors are chosen automatically each month based on their statistical significance from the initial set of 22 factors that have proven to be significant over time.

Significant Factors - Summary

**Valuation:** **Net Positive**

The effect of valuation factors on the model's expected return is net positive, though slightly lower due to the rally in equities so far in August. The P/E ratio continues to extend a significant positive contribution at 0.7 standard deviations ("SD" in this report), followed by the Price to Book ratio (0.2 SD), and partly offset by the

Complete Story »]]>

"Active management is forecasting" - Grinold and Kahn, *Active Portfolio Management* (1999). In order to achieve alpha from active asset allocation, the manager has to have a model that forecasts expected returns with reasonable degree of accuracy. Many authors provide an opinion on where stocks are going to go next, but not many have a model that does such forecasting accurately. What follows is a general description of how our model works, followed by the description of some of the most important factors that are responsible for this positive result of 3.8%.

Our forecasting model (the "PAR Model" as we call it) is a factor model that estimates expected equity return

]]>Our quantitative forecasting model continues to point to a positive 6-month expected return for the S&P 500 (SPY) of **3.8%**, despite economic headwinds. Accordingly, we recommend that investors are **overweight** equities relative to their benchmark weight.

"Active management is forecasting" - Grinold and Kahn, *Active Portfolio Management* (1999). In order to achieve alpha from active asset allocation, the manager has to have a model that forecasts expected returns with reasonable degree of accuracy. Many authors provide an opinion on where stocks are going to go next, but not many have a model that does such forecasting accurately. What follows is a general description of how our model works, followed by the description of some of the most important factors that are responsible for this positive result of 3.8%.

Our forecasting model (the "PAR Model" as we call it) is a factor model that estimates expected equity return

Complete Story »]]>

PAR Model mid-month July update - the model continues to turn more positive on U.S. equities, with six-month expected return for the S&P 500 (SPY) of 5.1%.

The change of +2.0% since June 30th is driven by positive changes in valuation (mainly Price to Book), the ECRI Weekly Leading Index, and the price of crude oil.

The PAR Model is a factor model designed to estimate the expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of the S&P 500 returns over economic, valuation and market variables. The factors are chosen each month as part of the model run, based on their statistical significance, from the set of 15 factors that have proven to be significant over time.

**S&P 500 6-m expected return: 5.1%**

**Recommended allocation: Overweight**

**As of June 30th: 3.1%**

**Change 2.0%**

*(click to enlarge)*

**Significant Factors**

*(click to*

PAR Model mid-month July update - the model continues to turn more positive on U.S. equities, with six-month expected return for the S&P 500 (SPY) of 5.1%.

The change of +2.0% since June 30th is driven by positive changes in valuation (mainly Price to Book), the ECRI Weekly Leading Index, and the price of crude oil.

The PAR Model is a factor model designed to estimate the expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of the S&P 500 returns over economic, valuation and market variables. The factors are chosen each month as part of the model run, based on their statistical significance, from the set of 15 factors that have proven to be significant over time.

**S&P 500 6-m expected return: 5.1%**

**Recommended allocation: Overweight**

**As of June 30th: 3.1%**

**Change 2.0%**

*(click to enlarge)*

**Significant Factors**

*(click to*

Complete Story »]]>

Accordingly, we are changing our recommendation to an Overweight to public equities - a change from our Underweight recommendation that was in effect in the last three months.

The PAR Model is a factor model designed to estimate the expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of the S&P 500 returns over economic, valuation and market variables. The factors are chosen each month as part of the model run, based on their statistical significance, from the set of 15 factors that have proven to be significant over time.

S&P 500 6-m expected return: 3.1%

Recommended allocation: Overweight

Prior month -4.4%

Change 7.5%

**Significant Factors**

The P/E ratio is one of the key measures of index valuation in

]]>The Performance Analytics' PAR Model changed to a positive stance in June, with the six-month expected return for the S&P 500 (SPY) of 3.1%.

Accordingly, we are changing our recommendation to an Overweight to public equities - a change from our Underweight recommendation that was in effect in the last three months.

S&P 500 6-m expected return: 3.1%

Recommended allocation: Overweight

Prior month -4.4%

Change 7.5%

**Significant Factors**

The P/E ratio is one of the key measures of index valuation in

Complete Story »]]>

Our model is a factor model designed to estimate the expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of the S&P 500 returns over economic, valuation and market variables. The factors are chosen each month as part of the model run, based on their statistical significance, from the set of 15 factors that have proven to be significant over time.

The model provides answers that tactical asset allocation managers need, such as:

- What's the expected return for equities right now?

- What are the factors that we should be looking at, that really affect equities?

**S&P 500 (SPY) 6-m expected return:**
**−**
**4.4%**

Recommended allocation: Underweight

Prior month -6.8%

Change 2.3%

The model had predicted a 6-month market drop, at -5.2% in March, confirmed by -6.8% forecast

]]>The PAR (Performance Analytics Return) Model* changed to a less negative position in May.

Our model is a factor model designed to estimate the expected equity return over a six-month period. The model is based on a dynamic multi-factor regression of the S&P 500 returns over economic, valuation and market variables. The factors are chosen each month as part of the model run, based on their statistical significance, from the set of 15 factors that have proven to be significant over time.

The model provides answers that tactical asset allocation managers need, such as:

- What's the expected return for equities right now?

- What are the factors that we should be looking at, that really affect equities?

**S&P 500 (SPY) 6-m expected return:**
**−**
**4.4%**

Recommended allocation: Underweight

Prior month -6.8%

Change 2.3%

The model had predicted a 6-month market drop, at -5.2% in March, confirmed by -6.8% forecast

Complete Story »]]>