Multi-Asset Investment Strategy, July 2011: Bullish on Equities, Less So on Commodities

by: Henry Ma, CFA

There were not many safe bets in June as stocks, bonds and commodities posted monthly declines for the first time since the end of the financial crisis in February 2009. Continuing concerns that Greece would default and signs that economies were slowing dragged down risky assets. The demand for safe haven assets, such as bonds, also diminished as ten-year Treasury rates hit below 3% and inflation pressures continued mounting.

My long-standing bearish view on bonds seemed vindicated for the month. The ten-year Treasury yield climbed by 20 basis points. The US dollar weakened against EUR and JPY when Greece approved budget cuts and tax increases in the last week of June to win bailout funds.

  • The S&P 500 Index declined by 1.7% for the month. EAFE index performed a little better with a 1.2% loss as all the major currencies appreciated against the US dollar. Emerging market equities had a negative month, down by 1.0% as well.
  • Oil slid for a second month by about 8%. In addition to concerns of economic slowdown, the announcement of the International Energy Agency on June 23 to release 60 million barrels of oil over 30 days from member nations and emergency stockpiles also added to selling pressure of oil. WTI crude oil, the US benchmark, declined to $95.42 per barrel. Brent crude oil, the global benchmark, was traded at $112.48 at the end of June. As the QE2 program was winding down, gold dropped again to $1500/oz, down by 2.4%. The DJUBS commodity index lost 5.8%, dragged down by energies and grains. USCI, an active commodity strategy, underperformed DJP by 0.4%.
  • REITs declined by 3.1%. There was no sign that house prices had hit a bottom.
  • The high yield bond index dropped slightly by 0.6% as interest rates moved higher. Surprisingly, emerging market debt bucked the trend. The yield-seeking investors found emerging market bonds attractive. The dollar-denominated emerging market bonds and local currency bonds both gained 0.6%.
  • The Multi-Asset Timing Strategy (MATS) lost 1.7%, underperforming 60/40 equity/bond benchmark by 0.6%. Table 1 shows the details of the strategy performance. Since we started tracking the strategy in December 2010, the MATS has still beaten the benchmark by 1.3%.

Table 1: Performance of MATS vs. 60/40 Equity/Bond Benchmark

(June 2011)

Portfolio Allocation Performance Performance
6/30/2011 6/30/2011 Since Inception
MATS Portfolio -1.7% 9.7%
Benchmark (60% SPY+40% AGG) -1.2% 8.4%
Excess Return -0.6% 1.3%
Domestic Equity
SPY 20.0% -1.7% 13.0%
Foreign Equity
EFA 17.5% -1.2% 13.7%
Emerging Market Equity
VWO 17.5% -1.0% 8.0%
High Yield Bond
HYG 10.0% -0.6% 7.8%
Emerging Market Bond
EMB 5.0% 0.6% 4.4%
ELD 5.0% 0.6% 7.7%
USCI 5.0% -6.2% 9.3%
DJP 5.0% -5.8% 7.1%
GLD 5.0% -2.4% 7.8%
IYR 10.0% -3.1% 15.2%
AGG 0.0% -0.5% 1.7%
Cash T-Bill 0.0% 0.0% 0.0%

Recently, many economists and Fed officials have downgraded their forecasts for growth and employment this year, projecting that the economy will expand 2.7 percent to 2.9 percent, down from forecasts ranging from 3.1 percent to 3.3 percent in April.

Although the economy hit a soft patch in the second quarter, global economic expansion, probably at a slower pace, will continue. The June ISM Manufacturing Index was reported at 55.3, higher than economists’ forecasts. The yield curve has steepened by 15 basis points in June. The spread between the ten-year Treasury rate and 3-month T-Bill stays at 3.15%. QE2 ended in June. The Fed believes that the current soft patch will be temporary and shows no intention of further quantitative easing, but it is still keeping interest rates on hold. The prices of all the risky and inflation assets, except commodities, are above their 200-day moving averages and my proprietary indicators. The model continues to recommend overweighting risky and inflation assets.

In July, I would recommend changing commodity allocation from overweight to neutral because it falls below the 200-day moving average. The economic slowdown in emerging markets such as China, will continue softening commodity demand in the near term. Oil still prices in the political risks in the Middle East and North Africa. The ending of QE2 also adds headwinds to commodity prices. I don’t think there will be a crash in commodities, but the upside is limited. Given the current cheap valuations on equities, I am more bullish on equity. Therefore, I will move the 5% allocation in DJP to 2.5% in EFA and 2.5% in VWO.

Risky assets (80%)

  • S&P 500 Index (NYSEARCA:SPY): 20%
  • MSCI Emerging Market Index (NYSEARCA:VWO): 20%
  • IBOXX High Yield Bond Index (NYSEARCA:HYG): 10%
  • J.P Morgan Emerging Market US Dollar Bond Index (NYSEARCA:EMB): 5%
  • Wisdom Tree Emerging Market Local Bond (NYSEARCA:ELD): 5%

Inflation assets (20%)

  • Dow Jones UBS Commodity Index (NYSEARCA:DJP): 0%
  • United States Commodity Index (NYSEARCA:USCI): 5%
  • Gold Index (NYSEARCA:GLD): 5%
  • Dow Jones US REIT (NYSEARCA:IYR): 10%

Bonds (0%)

  • Barclays US Aggregate Bond Index (NYSEARCA:AGG): 0%
  • US 3-month Treasury Bill: 0%.

Disclosure: I am long EFA, VWO, IYR, HYG.

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