Note: This market review was published on January 11, 2016 and may not be reflective of current market or investing issues.
“’Here be dragons,’ [is] a very interesting sentence. In early maps, you see images of sea monsters; it was a way to say there’s bad stuff out there.”
Thomas Sander quoted in Wikipedia
The Latin phrase, “HIC SVHT DRACONES”, meaning ‘here are dragons’ first appeared on the Hunt-Lenox Globe circa 1503-1507. But long before that, images of sea monsters would appear on early maps, warning travelers that much danger awaited them as they sailed into uncharted waters. After 2015, headed into 2016, this phrase seems to be very appropriate for the investing world. Last year, with stocks flat in the United States and down in many other parts of the world, there seems to be danger lurking in every country and around every asset class and sector.
In my last blog published in late December, I discussed the possibility of a 60% stock / 40% bond portfolio giving us very low real rates of return after adjusting for inflation (~2.4%) over the next five or even ten years. That prospect is discouraging enough, but when added to the “sea monsters” of volatile stocks, commodities and currencies, not to mention the specters of rising interest rates and geopolitical tensions, as an investor, one really begins to understand ‘here be dragons.’ Last month, I suggested that a broadly based non-correlated asset portfolio might be one solution for not only coping with volatility, but also better protecting assets while holding out the possibility of slightly enhancing returns.
So if you will, think that instead of just the tried and true 60% stock / 40% bond portfolio, an investor should consider using some real estate, some master limited partnerships, and maybe even a slice of managed futures. In this environment, even that expanded portfolio may not create enough non-correlation to produce a consistent ‘5% real return.’ Then I mentioned “alternative risk premia.”
Over the years, many academics have studied (and profited from) anomalies in global markets. For over 40 years, the classic work on these anomalies has been done by Eugene Fama (a recent Nobel Prize winner) and Kenneth French. The anomalies, or styles, identified by Fama and French are those of value, momentum and defensive stocks (although the strategies work with other asset classes), along with carry, which is essentially borrowing at a low rate and lending at a higher one. By using some long and short strategies, academically oriented investors have been able to produce positive results which offer sources of return that are largely independent of traditional risk factors, thereby helping us diversify the concentrated risk parameters of the “classic” 60/40 portfolio.
Of all the risk parameters Longview discusses, by far the largest risk we discuss on an ongoing basis is the risk of clients not being able to accomplish their long term goals. Here be the real dragons! Last month, I also mentioned that “investors need to focus on keeping their risk parameters in mind.” With domestic stocks and bonds both being highly valued, the use of these new strategies are introducing new risks (not higher risks) allowing us to offset the high valuation risks that are all too obvious. Remember, market volatility and risks are lurking everywhere, but to get the 5% real, maybe what we need to slay the dragons is hard work and broader thinking, along with a little love.
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