January 31, 2007
IT'S A GROWTH STORY (AGAIN)
Today's fourth-quarter report on GDP reminds that pessimism is a risky sport when it comes to forecasting America's economic outlook.
Annualized real GDP grew by 3.5% at an annual rate in the last three months of 2006, the government reported this morning. The pace was surprisingly strong for Mr. Market and the legions of dismal scientists who watch the economy for a living. The consensus prediction called for 3.0% growth, according to TheStreet.com.
Expected or not, 3.5% growth is impressive. That's the fastest pace since the red-hot rise of 5.6% in 2006's first quarter. More importantly, the 3.5% pace of 4Q 2006 came in a quarter that was widely said to be marred by the real estate correction. So said Larry Kantor, a managing director and co-head of research at Barclays Capital, in New York this morning. Your editor just happened to be at a press conference at the firm this morning when the GDP news arrived. Reflecting on the update, Kantor said that the drag on the economy in the recent past was hardly devastating.
What's more, Kantor predicted that the housing correction, such as it is, will fade as an impediment to the U.S. economy in 2007. As he put it, the economy will "reaccelerate" this year. The housing market doesn't need to impress to see a stronger economy. Rather, housing merely has to flat line, he said. And since housing prices have already fallen, that implies that the real estate market looks likely to hold steady if not post mild growth.
Overall, it's hard to argue. The fourth-quarter GDP increase strongly suggests that upward momentum in growth has returned. The idea that a recession is lurking just around the corner is all but dead in the wake of today's news. The implications are many, starting with the revised thinking that now weigh on the Federal Reserve.
You may recall that Fed Chairman Ben Bernanke argued last year that the expected slowdown in the economy would take the edge off the uptick in core inflation of late. The Fed is widely reported to have a "comfort zone" of 1-2% for core inflation. Alas, that comfort zone has been breached recently, with core inflation reaching an annual rate of 2.9% last September, up from 2.0% a year earlier. The pace has come down a bit, with core inflation running at 2.6% as of December 2006. But with today's GDP report, it seems prudent to wonder if the economy will moderate enough to push core inflation lower, and thereby head off a fresh round of rate hikes.
As we write, the FOMC has yet to announce its interest-rate decision scheduled for this afternoon. But whatever comes, the markets will now be looking for some recognition that the central bank is prepared to deal with the stronger-than-expected economic growth. Reading the tea leaves of the FOMC statement will take on that much more significance.
The good news is that the employment cost index grew by only 0.8% in the fourth quarter, down from 1.0% in the third quarter. "The moderate growth in the ECI holds little evidence that a tightening labor market will exert wage-induced pressures on inflation," David Resler, chief economist at Nomura Securities in New York, wrote in a note to clients this morning.
As for the surprisingly strong economy, that's the story to watch, and it may color economic reports for some time. If the markets have been willing to give the Fed the benefit of the doubt before, we expect deterioration in the inclination going forward. Ben may need to prove himself all over again in 2007.
January 30, 2007
Earlier this month, we observed that the inflation-indexed Treasury market was priced for the assumption that inflation was a fading threat. But since then, the TIPS market appears to be having second thoughts.
On December 4, a 10-year TIPS yielded a real (inflation-adjusted) yield of 2.11%, according to U.S. Treasury data. As of last night's close, the 10-year TIPS changed hands at 2.50%--the highest since last October.
As our chart below shows, the 10-year TIPS yield has jumped dramatically in recent weeks. Is this a good time to jump in?
Clearly, the bond market generally has become more anxious about inflation's threat in recent weeks. The nominal 10-year Treasury now yields nearly 4.90%, the highest since last August.
As for TIPS, they now offer the following deal: buy a 10-year TIPS and lock in a real yield of 2.50% for the next 10 years. Will that suffice as compensation for any future inflation?
One way to measure your odds success comes by comparing the higher yieldingnominal 10-year to the 10-year TIPS yield. The spread now works out to 2.40%--the highest since last September. What it means is that as long as top-line consumer prices run below 2.40% for the next 10 years, buying a 10-year TIPS in the here and now will fare worse than buying its nominal equivalent.
For perspective, consumer prices advanced by 2.6% in 2006, down from 3.4% the year before. By that measure, it's still a close call as to whether TIPS are the better deal at the moment. Unless you're expecting a material and sustained uptick in inflation in the years ahead from current levels, you're better off with standard Treasuries.
Perhaps some of the rise in TIPS yield of late is tied to worries surrounding tomorrow's FOMC meeting, which will issue its latest decision on the price of money. By most accounts, this will be another non-event and Fed funds will remain steady at 5.25%. Fed funds futures are expecting no less, and for well beyond tomorrow's FOMC confab.
Of course, keeping rates steady if inflation's set to rise could easily stir TIPS buying. That doesn't mean the TIPS buyers are any smarter than the rest of the market, but it may explain the jump in TIPS yield of late.
Nonetheless, the wider market will need more convincing evidence that inflation's still bubbling. The next opportunity for reading inflation's tea leaves comes on February 21, when the Labor Department dispenses the January report on consumer prices.
Meanwhile, the TIPS market is looking anxious. If the anxiety keeps stirring, the real yield on a 10-year TIPS will be too good to pass up, even if inflation's not about to skyrocket. For our money, a jump to a 3.0% yield on a 10-year TIPS would convince us to reconsider the asset class. Meanwhile, we're just lukewarm, but we're watching.
January 29, 2007
IT'S ALL ABOUT THE DIVIDENDS
Divining the future by dissecting the past is, like parachuting and wrestling crocodiles, a venture saddled with more than a little risk. Yet each is thrilling in its own way, and at times may even offer perspective--assuming you don't lose an arm and a leg, figuratively or literally, depending on the sport.
Ours is a quantitative adventure in the land of investing, and among the various statistics we routinely review is the equity risk premium (ERP), and so the risk is limited to those little bits of paper with images of George, Abe, Alex, et. al. There is much debate about the underlying rationale for the ERP, or the excess return thrown off by stocks relative to the risk free rate, which we define here as the 12-month rolling total return on the S&P 500 less the same on 3-month T-bills. Nonetheless, the ERP is quite real, or at least it has been in the past. The question is whether it will continue in the future, and if so, by how much?
As our chart below illustrates, the ERP is hardly a static number. Back in July 1997, the trailing 12-month ERP was an extraordinary 47%; in September 2001, the ERP over the previous year had turned negative to the tune of -31%. The average ERP turns out to be around 7.9% since 1987 through the end of last year.
The ERP in recent years has tended to stay with in a range of 4-12%. Over time, that could deliver a tidy gain for the patient, long-term investor. Ah, but deciding if 4-12% will be high, low or middling is the asset allocator's dilemma. Of course, there is no good answer, given the history of prognosticating investment returns and the myriad of factors that ultimately go in to determining how the future unfolds.
That said, one's expectations of the future may be informed by the outlook for equity dividends. As Robert Arnott observed in a 2003 essay, most (nearly two-thirds) of the ~7.9% annualized total return of the U.S. stock market for the 200 years through 2002 came from dividends.
Further, dividend growth has averaged about 1% over the rate of inflation during the previous two centuries, points out Arnott, who's chairman of Research Affiliates, a research shop that designed the "fundamental" indices that have become the basis for a suite of new ETFs, including PowerShares FTSE RAFI US 100 (NYSE: PRF). Alas, the inflation-adjusted per-share growth in earnings and dividend growth since 1965 has been zero, zilch, nada.
History, in short, suggests that the long-term return on equities, and thus the ERP, will depend heavily on dividends. Will dividends grow overall for equities? Will the rate of dividend growth lag, pace or exceed inflation? What will the risk-free rate be going forward? We don't have answers, although we have some guesses. In any case, we know the right questions to ask.
January 26, 2007
THE BOND MARKET BLINKS
There was enough weakness in yesterday's report on existing home sales for December to keep pessimism alive about the economic outlook for 2007. But the bond market wasn't waiting around for definitive signs and instead ran for cover. (Update: Since we posted this morning, new home sales numbers for December were released, reporting a gain of 4.8%. As a result, new home sales rose last month to their highest since April, offering an optimistic offset to yesterday's less-inspiring news on existing home sales.)
The selling yesterday pushed the yield on the 10-year Treasury up sharply, closing at around 4.87%, the highest since last August. The notion that the economy will stay fairly robust has apparently taken root in the hearts and minds of bond traders and planted the fear that rates may rise before they fall. For the fixed-income set, that's reason enough to become defensive.
But while the trading floors focused on the 10-year Note seem to have blinked in deference to the growth-will-be-stronger-than-expected crowd, there are no signs of capitulation (yet) over in Fed funds futures pits. Looking at the array of contracts expiring in coming months, one theme is clear: the popular bet at the moment is a Fed that will hold rates steady at 5.25% for the foreseeable future. That's been the bet for some time now, based on recent history in Fed funds trading, and it appears to be the consensus view for pricing Fed funds through the summer.
As we reported earlier this week, there are a number of seers who forecast that 2007 will be a decent, if not exactly impressive year for general economic expansion after all. One optimist we heard speak on Tuesday said as much, and we detailed his thoughts here.
But at least one dismal scientist is warning otherwise by saying that economic risk still lurks and that this is no time for complacency. Nouriel Roubini, who's been attending the talkfest a.k.a. the World Economic Forum in Davos, Switzerland, advises that he continues to see trouble ahead. On his blog, Roubini wrote on Wednesday that he was on an economics panel at Davos and he alone "expressed some concerns about a U.S. hard landing that could take the form of a growth recession or an outright recession." The head of Roubini Global Economics also outlined three potential risks that could derail the soft-landing scenario that many now expect for the U.S. economy:
1. A continued housing recession that spills over into other sectors of the economy.
2. the delayed effects of the Fed Funds increase and the beginning of a credit crunch in the mortgage market...
3. Oil prices that remain high, albeit lower than last year's peak
The bottom line, Roubini wrote: "There are still meaningful risks of an outright recession this year."
Roubini may be in the minority on the economic outlook, but there's enough conflicting evidence (and more to come?) that will keep this debate alive in coming weeks and perhaps months. As we've written before, ours is a period of transition, which is a clever way of saying that the future's unclear, or at least less clear than it has been in the last couple of years. Given this tender climate, one or two surprising data points could change perceptions far and wide. For the moment, the consensus seems to have swung around to the idea that the economy will continue to bubble. For what it's worth, that's our view. But like everyone else, we reserve the right to adjust our outlook. Heck, we'll admit the obvious right here and now and say that we don't really know what's coming, even if we occasionally adopt an attitude in our prose that suggests otherwise.
Perhaps the only comfort is that when it comes to strategic-minded portfolio design, the performance numbers tell us most of what we need to know. With that in mind, we'll continue to take profits in asset classes the longer they run and redeploy capital into asset classes that have suffered relatively or absolutely. Such a strategy won't deliver stellar gains in the short term, but it's the only game in town if you want to impress in the long haul.
January 25, 2007
THE WORLD ACCORDING TO MILTON
The late, great Milton Friedman reordered thinking on the relationships between monetary policy, inflation and the economy. In essence, Friedman argued, and quite persuasively, that money supply matters. Ignore it or mismanage it and you risk trouble. Such insight had eluded the Federal Reserve early on, most notoriously during the Great Depression, which was exacerbated by the central bank's monetary blunders.
Alas, Friedman put forth no formal treatise on the matter since he co-authored the monumental A Monetary History of the United States with Anna Schwartz in 1963. Friedman wasn't exactly quiet in the decades since his 1963 magnum opus hit the streets. In columns, interviews with journalists and a variety of papers, the grand old chief of monetarism opined far and wide. But the paper trail is somewhat messy. In an attempt to bring some order to Friedman's thinking during the last several decades, Edward Nelson, an economist at the St. Louis Fed, has sifted through the record and distilled what is arguably the essence of Friedman's views since the early 1960s. Although his comments generally support his earlier findings on monetarism, Friedman wasn't so intellectually rigid as to remain immovable when empirical evidence suggested otherwise. His thinking, in short, evolved, but mostly on tactics rather than strategy.
For the details, take a look at Nelson's paper, Milton Friedman and U.S. Monetary History: 1961-2006 As a teaser, here are few of Milton's observations that caught our eye in Nelson's compilation:
“Direct control of prices and wages does not eliminate inflationary pressure. It simply shifts the pressure elsewhere and suppresses some of its manifestations. The only way to stop inflation is to restrain the rate of growth of the quantity of money.” --1966
“You can look around the world and find countries that have had very strong trade unions and no inflation… The fact is that there is little relation between trade unions and inflation.” --1970
“The best way to hold rates down in the long run is for the Fed to raise them temporarily.” --1973
“There is no way of slowing down inflation that will not involve a transitory increase in unemployment, and a transitory reduction in the rate of growth of output. But these costs will be far less than the costs that will be incurred by permitting the disease of inflation to rage unchecked.” --1974
“If you spend more on oil, doesn’t that leave you less to spend on something else? Why don’t other prices come down, or not rise as rapidly? It’s a complete fallacy to suppose that the rise in the price of oil, or of other commodities, has had any significant effect on inflation.” --1974
“If Mr. Carter tries to put his advisors’ policies into effect and succeeds in doing so—including getting the Federal Reserve System to speed up substantially the rate of monetary growth—there might be a sudden spurt in the economy and a quick reduction in unemployment. However, these good results would be temporary. By 1978 or 1979, inflation would be back in double digits and wage and price controls would be in place or in contemplation. By 1980 at the latest, unemployment would be rising sharply. As Machiavelli might say: what a way to face the 1980 election!” --1976
“[I]nflation is a lot like alcoholism. When you drink, the good effects come first, and the hangover comes the next morning. When an inflationary period [i.e., the launch of an easy monetary policy era] starts, spending goes up and employment rises along with it. By printing money at a faster rate you may be able temporarily to create an appearance of prosperity, but only so long as you fool the people. Once the public comes to realize what is going on, higher inflation means higher unemployment! Just look at the example of the U.S., Great Britain, and every other country.” --1977
“The high price of cars doesn’t cause inflation any more than a drop in the price of hand calculators causes deflation.” --1978
“The problem is not, as President Carter asserts, a lack of confidence. The problem is rather that the public is very confident that the government will produce inflation and will mismanage the economy. We do not need more confidence in bad policies. We need better policies.” --1979
“The use of quantity of money as a target has not been a success. I’m not sure I would as of today push it as hard as I once did.” --2003
“In my original support for a straight money target, I always emphasized that it was partly a case based on ignorance, based on the fact that we really did not understand sufficiently well the detailed relationship between money, income, interest rates, and the like to be able to fine-tune, that our goal should be to develop a detailed enough understanding so that we could do better than a simple constant monetary growth target. However, I believe still, as I did then, that constant monetary growth would produce a highly satisfactory price path, and, if it enabled you to get rid of the Federal Reserve System, that gain would compensate for sacrificing the further improvement that a more sophisticated rule could produce.” --2003
January 24, 2007
IS VOLATILITY SET FOR A COMEBACK?
The last several years have been remarkable for the gains across the major asset classes. A commensurate, albeit lesser-known trend is the fall in volatility generally.
Consider our chart below, which graphs rolling 36-month, annualized standard deviation of monthly equity total returns through December 31, 2006. It's clear that stock markets overall have become calmer, gentler beasts. The trend has been particularly notable in emerging markets, as per the MSCI Emerging Markets Index. At the end of last year, the benchmark's volatility weighed in at an annualized 17.6 standard deviation for the past three years, down from more than 30 in 2001.
A shift in volatility trends may or may not aid investors. Much depends on the context. As valuations high or low? Is the economy in recession or growing? Does a bull or bear market prevail? No too periods are alike, which is what makes investment analysis so much fun, and often times so frustrating for those who like reliable predictions and tidy profits.
History viewed through the prism of volatility is instructive, but not always prescient about the morrow. Indeed, the rising volatilities of the late 1990s accompanied a surge in prices. In contrast, the last few years have witnessed falling volatilities and strong bull markets.
It's tempting to draw the lesson that bull markets can persist in both periods of falling and rising volatility. But the future may not be so kind to such thinking. Higher volatility is probably coming, one day, and history reminds that sometimes higher volatility is forged by falling prices.
For those wearing rose-tinted glasses and expecting only sunny skies, a change in the volatility climate could be shocking. For those prepared, by contrast, a jump in volatility offers a fresh chance to exploit the portfolio-wide blessings that flow from rebalancing. Higher volatility may be coming, but the trend could be just the thing that strategic-minded investors have been waiting for.
January 23, 2007
THE GLASS IS STILL HALF FULL
The bond market's been arguing with the stock market in recent months about where the economy's headed. On the fixed-income side, the outlook has been one of relative pessimism for 2007. Stocks, by contrast, see a brighter future for this year. By one economist's reckoning, the stock market has won the debate.
So said Nariman Behravesh, chief economist for Global Insight, at a Dow Jones-sponsored conference in New York this morning. Behravesh opined that U.S. economic growth is stronger than some assumed it would be. Corporate earnings growth in 2007 will be "decent" after all. Slower than in '06, he acknowledged, but still fairly robust. "There's a lot of strength in the U.S. economy," he said.
One of the smoking guns that leads him to this relatively rosy forecast for 2007 is the strong upward revision in the monthly employment reports of late. Consider September's original estimate of 51,000 new nonfarm jobs created, he asked the audience of journalists in attendance. The revised numbers eventually showed that the economy tacked on additional 203,000 new jobs that month--four times higher than the initial estimate. Upward revisions overall have been typical, he added.
There in a microcosm has been the story for the economy of late, Behravesh suggested. Growth is more resilient than some have recognized. As a result, the Fed isn't likely to cut rates any time soon and may even raise them a notch or two later this year.
What caused so much pessimism in weeks past? A focus on housing, which has clearly been stumbling. But overemphasizing housing's slump has been fraught with risk in terms of projecting what comes next for the economy. Behravesh said that housing represents all of 6% of the economy. That's not insignificant, but neither does it mean that housing controls America's economic destiny.
In any case, the spillover effect from housing's correction hasn't been anywhere as destructive as some thought it would be. In fact, Behravesh said that demand for housing is already showing signs of making a comeback. Yes, there's still excess supply to work off, but the fact that demand has faded away encourages the notion that the worst is past,
as Alan Greenspan observed back in November.
All of this is already reflected in the bond and stock markets, or so one could argue. The yield on the 10-year Treasury bond, as we write, is roughly 4.80%--up 40-plus basis points from early November. In other words, bonds (whose prices move inversely to yields) have taken it on the chin lately. Stocks, by contrast, have gone from strength to strength. The S&P 500's rally since last summer has slowed somewhat this year, but it's clear that the buyers are still running the show. In fact, the S&P 500 this afternoon is near its highest since the all-time peak in 2000, and even that former pinnacle may soon be taken out if the recent momentum keeps up.
Optimism that the economy will keep chugging along quite nicely is, again, in the air. The year may pale compared to the recent past, but the odds of an outright recession are now looking dim. Of course, that leaves some unanswered questions, starting with, what to make of the inverted yield curve?
January 22, 2007
ARE EMERGING MARKETS STILL WORTHY?
Emerging markets stocks have been hot in recent years, but there are signs that the momentum is slowing . The MSCI Emerging Markets Index, in dollar terms, has slipped 1.7% so far this year. But whether the index turns in another year in the black or slips to red is irrelevant for one wealth manager. Jeffrey Troutner of TAM Asset Management is rethinking the value of emerging markets stocks as a strategic holding. In an interview in the January 2007 issue of Wealth Manager, Troutner told your editor that emerging markets have disappointed over the long haul. That's quite a statement coming from someone who was one of the early proponents of the asset class back in the mid-1990s. To learn more, we recently had a long chat with Troutner, with excerpts published in the January issue of WM. You can read along here....
January 19, 2007
THE RETURN OF RED
On more than one occasion your editor has lamented the lack of good buying opportunities on the asset class level in 2006. If January's experience so far is any indication, 2007 may be kinder for bargain-minded investors with an eye on the long term.
As our table below indicates, the red ink is starting to pile up this month. A few weeks hardly reveals much, if anything, about the strategic future for asset class returns. Nonetheless, we're hopeful that the prospects for rebalancing are looking brighter relative to the recent past. No, we don't hope for bear markets, but we're prepared to take advantage of them when they inevitably return to one or more asset classes. That, as they say, is what makes strategic rebalancing go 'round.
Whatever's coming, 2007 so far is clearly a change from recent years, when all the major asset classes tended to post gains. Indeed, 2006 wasn’t much different from 2005, 2004 or 2003 on that score. Make no mistake: we're not complaining. We like bull markets across the asset class spectrum as much as the next fellow. But as a student of market history, we also realize that such parties can't last forever, even if recent history suggests otherwise, without one of two players stumbling.
Our obsession in recent months has been trying to guess where opportunity (relative or absolute) would appear next, and when. A tough call, as always. As last year was winding down, commodities looked like a safe bet, given all the speculative frenzy the asset class has witnessed in recent years. The underlying fundamentals for the long run are still bullish, but it's been clear from analyzing futures contracts that the hedge funds went too far in buying up raw materials. Contango, as they call it, had run amuck. That is, long-dated contracts we're trading at a premium to short-dated ones. No matter what you think of contango, eventually it'll take a toll for long-only investing. Until contango reverses, commodities overall (particularly crude oil) remain vulnerable to selling.
That said, the unwinding of the commodities play now appears to have begun in earnest, as the red ink in the table above for this year suggests. Emerging markets stocks are also taking a tumble after a strong multi-year run, as are equities in developed foreign markets. U.S. stocks are still in the black, but we wouldn't be surprised to see some selling there as well. TIPS too are on the defensive courtesy of the new-found respect for Bernanke's Fed to do the right thing when it comes to fighting inflation.
One asset class that seems overdue for a correction is REITs. Then again, we've been expecting an extended sell off for several years and have been proven wrong time after time. Any number of theories are put forward to justify the extraordinarily long-running and robust bull market in real estate securities, starting with the allure of relatively high yields in an otherwise low-yield environment. Whatever the reason, so far this year, we're looking foolish again, with REITs climbing 3.8% so far this month. It's hard to imagine the asset class can keep up the momentum for the rest of the year after such a long run, but then again, who knows? REITs have continued to defy gravity for so long that it's not unreasonable to think they can do so for a little longer.
While we don't know what's coming, we do know what's been, which tends to inform the future, if not predict it exactly. As such, we're ready, willing and able to deploy our overweight position in cash to more productive use. Nonetheless, we're disposed to wait a little longer for better rebalancing opportunities. The red ink, we modestly predict, will spread. Exactly where, when and by how much we can't say. No matter, since we're ready to pounce when the time comes.
January 18, 2007
The latest inflation numbers are in and, once again, there's something for everyone in the December report on consumer prices.
As usual, the immediate focus will be the top-line CPI number, which posted a sharp rise last month relative to November. Consumer prices advanced by 0.5% in December after standing pat in November, the Labor Department advised today. The main source for the rebound in prices was energy.
Ah, but energy prices are retreating this month, suggesting that the December CPI is already out of date and that January's CPI update will provide a more comforting profile in the eternal battle against inflation. Crude oil futures continue to tumble in '07 and now change hands at the lowest levels since mid-2005.
Perhaps salvation is coming on the inflation front, although before we get too giddy, let's review the core CPI numbers, which is the Fed's primary concern. On that score, there's reason to wonder what comes next. Core CPI, which excludes energy and food prices, made a comeback last month, jumping 0.2% in December, the highest since September. That puts the annual change for core CPI at 2.6%, unchanged from November.
As our chart below reminds, it's too early to celebrate the death of core inflation and too early to say that the future looks ugly. The upswing in this measure of pricing pressure that began in 2004 is still intact. What's unclear is if core CPI has run its course and is headed for lower realms, or if it's gearing up for another surge.
What this means for monetary policy is more of the same. The Fed will continue to sit on its hands, neither raising nor lowering interest rates when the FOMC meets next at the end of this month. At some point, core CPI will reveal its true nature, and the Fed will feel compelled to tighten or loosen. But the signals are still crossed, the numbers are still mixed and the waiting game continues.
January 17, 2007
TOURING THE GLOBE BY EQUITY MARKET CAP
Asset allocation, we're told, is the critical variable driving success and failure for diversified portfolios in the long haul. If you get asset allocation wrong, market timing and security selection can't save you. We're inclined to agree, although that generally sound counsel suffers from subjectivity once you go into the details of designing actual portfolios. One man's notion of an asset allocation dream is another's nightmare. Perhaps that's inevitable, as every asset allocation should be custom designed for each investor's goals, risk tolerance, time horizon, and so on.
Standard benchmarks, in short, are hard to come by for asset allocation. But if there's such a thing as a default, Mr. Market's take on how to allocate money arguably comes closest to such an ideal. By "Mr. Market" we're referring to the distribution of market capitalization. To be sure, market cap is under attack these days from new-fangled concepts of benchmark crafting, i.e., fundamental indexing. But say what you might about market cap, it still seems to be the most objective measure of the capital markets. You may or may not want to own equities based on market-cap allocations, but the measure remains a valuable and largely objective standard by which to gauge trends in the financial markets.
With that in mind, we crunched the numbers on the world equity markets, courtesy of data from S&P/Citigroup Global Equity Indices. Although this benchmark series offers dozens of indices, we looked at seven with the idea of forging a big-picture overview of the changing face of market-cap equity allocations on a global scale.
Theoretically, market-cap-based allocations are optimal for the average global investor with an infinite time horizon, meaning that such allocations are suitable for everybody in the aggregate and nobody in particular. So while the following shouldn't be considered informed counsel on how to divvy up a portfolio, it does offer some context for thinking about designing a global equity portfolio and how Mr. Market's voted in recent history.
Let's start with the U.S. As you can see from the table below, the good 'ole U.S. of A.'s market capitalization represented 43.9% of the global equity capitalization on January 1, 2007. (This and all figures that follow are dollar-based numbers, meaning that allocations would look different if we chopped up the markets based on euros, yen or other currencies.) A market-cap-inspired view of the world implies that U.S. stocks should comprise 43.9% of a global equity portfolio. That's down from 47.2% at the start of 2006 and 53.4% at the beginning of 2000. On the other hand, the U.S. share of world equity markets in 2007 is up from 1995's 40.7%.
The world's second-biggest economy has fared worse. As this year opened, Japan's market-cap weight of global equities was 10%, down from 11.5% the year before and from 23.1% in 1995.
Europe's slice of the equity pie, on the other hand, is rising. At the start of 2007, Europe's weight was 30%, up from 27.1% a year ago and from 25.1% in 1995.
Ditto for Asia Pacific ex-Japan. The region's market cap share outside of Japan climbed to 5.3% this year from 4.8% in 2006 and from just 2.3% in 2000. This year's tally is also up from 1995's 4.6%.
In fact, emerging markets overall are taking a bigger share of the global economy's market cap, although not as much as one might think. At this year's start, emerging markets claimed 7.5% of the planet's equity market capitalization, up from 5.9% the year before and from 3.8% in 2000.
Latin America's collective market cap rose slightly in the past year to 1.6% of global equity capitalization from 1.3% in 2006. Longer term, however, Latin America's stock markets are a shrinking presence, falling from a 1.9% share back in 1995.
Finally, it's instructive to look at global equity markets less the U.S. presence. By that measure, there's growth to recognize, with global ex-U.S. posting a 56.1% share at this year's open, up from 52.8% in 2006 and from 46.6% in 2000. Relative to 1995, however, foreign markets' share of global equity cap has fallen slightly.
All of which provides some perspective on how to indulge in active money management. If there's any hope of beating the global equity markets, one has to build portfolios that differ from Mr. Market's allocation. Now that you know how Mr. Market's bets are placed, the question is whether you're inclined to take an alternative view. Many have tried and failed, but hope springs eternal, even on a global scale.
January 16, 2007
EXPECTING HIGHER INFLATION IS NOW A CONTRARIAN BET
On Thursday, the government will release its December report for inflation. But it looks like it'll be a non-event because the crowd believes that consumer prices are no longer a threat.
One measure of the market's comfort that prices are contained can be seen in inflation-indexed Treasuries, otherwise known as TIPS. The spread between the yields on standard 10-year and 10-year TIPS was a mere 2.28%, as of last Friday's close. That's near the lowest levels of recent years. The implication: the market's not worried about future inflation and has become less worried of late.
Contrarians may want to take a closer look. The fact that the yield spread between nominal and inflation-indexed 10-year Treasuries has fallen to 2.28% also means that the break-even hurdle for TIPS is lower. If top-line inflation runs above 2.28% going forward, a 10-year TIPS will probably deliver a higher overall total return compared with a nominal Treasury of the same maturity.
Of course, Mr. Market thinks otherwise, which is why the spread (or breakeven point) is so low these days. Indeed, top-line inflation rose by just 2.0% for the past year through last November, or 28 basis points below the spread. Expectations are low that inflation will exceed that level any time soon. Then again, it was only in July that consumer prices were advancing by more than 4% a year. But that was so yesterday.
Consider that the iShares Lehman TIPS ETF has lost one-half a percent over the past 12 months through January 12, according to Morningstar.com. That compares with a 2.4% gain for the iShares Lehman 7-10 Year Treasury ETF. In short, betting that inflation would rise has been a losing proposition.
The question, as always, is whether yesterday's winning bet will continue to win? It's a close call at this point, judging by the outlook for December's inflation report. The consensus prediction for Thursday's CPI report calls for a 0.4% rise in top-line inflation for December, according to Briefing.com. If accurate, that would be the highest monthly pace of inflation since July and a sharp jump up from November's zero percent change. Even so, will a 0.4% rise in inflation be enough to convince Mr. Market that TIPS are again worthy of ownership at the expense of nominal Treasuries? Tune in Thursday morning for the answer.
January 15, 2007
The markets are closed today in the United States, in honor of Dr. Martin Luther King Jr., but the government's printing presses never take a holiday. In fact, the Federal Reserve has been spitting out dollars at an annual pace not seen since in nearly two years.
M2 money supply advanced by 5.6% for the past 52 weeks through January 1, 2007, according to Fed data. That's the fastest rate of increase for 52 weeks since February 7, 2005. Calculated on a 10-week basis, M2's pace isn't quite a strong relative to recent history, but it's clearly taken flight and is just a shade under the previous 10-week peak of 2.4% set back in May 2003.
No matter how you slice it, money supply is growing at an accelerating pace these days. The optimistic interpretation is that the trend is as it should be. The economy has been holding up better than anticipated and so more money is needed to grease the growth. But let's not go overboard with the definition of growth. GDP, at last count, was expanding by an inflation-adjusted 2.0% a year in the third quarter, down from 2.6% in the second quarter. No, the economy's not about to stumble into recession, but neither is it about to surge.
Inflation, meanwhile, is looking more cooperative, at least from a top-line perspective. But the jury's still out on whether anxiety's still warranted for core inflation (which the Fed watches like a hawk, or dove, depending on your perspective). Consumer prices less food and energy advanced by 2.6% for the year last November, a pace that's close the highest logged so far in the 21st century.
Thus, the question du jour: Should M2 money supply be growing at an annual pace that's nearly triple the rate of GDP growth and more than twice the annual rate of increase in core inflation? An answer may avail itself later this week, when the Labor Department releases the inflation update for December. In the meantime, we can gaze at the money supply trend and wonder if it'll continue and if such things still have relevance in the 21st century.
January 12, 2007
DECEMBER'S RETAIL REBOUND
Another day, another reason to think that the economy's stronger than previously thought. Or, perhaps it's more accurate to say that the economy's not as weak as the consensus expected.
Whatever language you prefer, there's no getting around the fact that the economic data trickling in continues to offer reasons for rethinking that 2007 will deliver pain and suffering on a macro scale. But lest we get too excited, we don't expect that GDP will suddenly surge to the sky. A downshift in economic momentum is still underway, but the downshift looks set to be mild, or at least milder than many recently thought.
The latest evidence for a touch more optimism comes by way of this morning's retail sales report for December. The U.S. Census Bureau reported that retail and food service sales advanced by 0.9% last month over November.
That's impressive on several fronts. First, 0.9% for December is more than twice as strong as December 2005's 0.4% gain. Second, a 0.9% rise is the best monthly gain since July's 1.4% surge. In addition, looking at 12-month changes in retail sales reveals that December's pace of 5.4% over the previous December suggests a turnaround is in progress.
That's impressive on several fronts. First, 0.9% for December is more than twice as strong as December 2005's 0.4% gain. Second, a 0.9% rise is the best monthly gain since July's 1.4% surge. In addition, looking at 12-month changes in retail sales reveals that December's pace of 5.4% over the previous December suggests a turnaround is in progress.
Granted, it's too early to say for sure, but it's clear for the moment that Joe Sixpack's penchant for spending is showing renewed signs of strength. One reason for thinking that there's still life left in consumer spending comes by noting that the biggest gain in the retail sales subsectors for the past year was in the discretionary spending realm of electronics and appliance stores. Purchases of TVs, DVD players, washing machines, etc. posted a 15% advance on the year, or about three times as fast as retail sales generally.
Retail sales trends can fickle, of course. But when you consider the latest report with other modestly encouraging data series of late (such as yesterday's initial jobless claims and the December jobs report), it's getting easier to think that the economy isn't headed for the swamps.
Adding to the reasons to be cheerful is the tumble in oil prices. A barrel of crude closed yesterday under $52, down from nearly $80 back in the summer. The sharp cut in energy prices (if it lasts) may boost consumer spending in the coming months and quarters by putting more discretionary dollars into Joe Sixpack's wallet.
All of this is giving encouragement to stock market bulls, who have pushed the S&P 500 to within shouting distance of its old 2000 all-time highs. The bond market, meanwhile, continues to suffer the pain that flows from rethinking the economy's strength when it comes to pricing fixed-income securities. The yield on the 10-year Treasury yesterday continued rising, topping 4.75% for a time in intraday trading--the highest since last October. If there's any one left who thinks the Fed will cut rates at the end of this month, they're living a solitary existence.
But make no mistake: this is still a time of transition. It's easy to get caught up in the moment and think that all's well. But risks abound and new economic data can bring monumental shifts in perception at this juncture. Yes, the economy may avoid a recession in the near term. But all the asset classes have run higher for an unusually lengthy stretch through the end of last year. Disappointment on some front is overdue. If it comes in commodities, that may embolden bulls in the other asset classes. If bonds take a hefty tumble this year, that may for a time encourage more equity purchases. But when investors realize that selling in bonds translates into higher interest rates, the notion of risk may return with a vengeance.
January 11, 2007
Today's update on initial jobless claims deals another blow to the notion that the Federal Reserve will lower interest rates any time soon.
The Labor Department reported this morning that workers filing for unemployment benefits for the first time dropped to 299,000 last week. That's the lowest number of weekly filings since last July 22.
The evidence, in other words, is mounting that the economy isn't as weak as previously thought. The outlook adjustment promises to weigh heaviest on the bond market, which seems to be rethinking the appropriate level of yield on the benchmark 10-year Treasury. As of yesterday's close, the 10-year traded at 4.68%, up from 4.43% on December 1.
But while there's a rising suspicion that long rates should be higher, the consensus on the short end of the curve hasn't budged much relative to recent history. Fed funds futures still anticipate that the Fed will continue to keep rates unchanged at 5.25% when the FOMC meets at the end of this month to consider the price of money anew.
In other words, long rates appear to be headed higher while short rates are expected to hold steady. The inverted yield curve, as a result, may be living on borrowed time. That's perfectly logical if the economy is poised to hum along for the foreseeable future. Inverted yield curves are said to be an early warning sign of recession. But it's getting harder to reconcile the recent inversion of the curve with the economic data coming forth.
Stepping back and surveying the bigger picture suggests that slower economic growth is still likely. But the odds for recession are fading. Nonetheless, it'll take another month or two of economic data to confirm that view. That starts with several key economic updates for December arriving next week, including housing starts and industrial production. It's easy to rethink the future, but the past still appears one data point at a time.
January 10, 2007
Is there any value left in the world's equity markets? That depends on your definition of "value."
A review of market fundamentals and performance for 2006 certainly paints an encouraging profile (based on data for S&P/Citigroup Global Equity Indices). As our first table below shows, it was hard to lose money last year by owning stocks. European emerging markets were the hottest region, posting a total return of nearly 47%. Worldwide, stocks rose a tidy 21%.
Will last year's party make it tougher to celebrate in 2007. Perhaps, although we wouldn't discount the power of upward price momentum, at least not yet. Nonetheless, dividend yields, partly as a consequence of the rise in equity prices, are slipping. The range of yields at last year's close was 2.97% on the top (Mid-east and Africa) down to 1.13% for Japan, based on our subjective view of the world. That's a slight drop in the range from October 31, when yields ran up as high as 3.07%.
By the measure of price-earnings ratio, things arguably look a little brighter. In particular, Latin America's stocks were less expensive by this measure at last year's close relative to October. Of course, with news of Chavez's plans to turn Venezuela into the new Cuba roiling markets in the region these days, bargains in Latin America may not be all they're cracked up to be.
Nonetheless, world equities traded at slightly higher valuations at 2006's end vs. October 31 on a price-to-cashflow. S&P/Citigroup World index traded at a 9.63 P/CF on December 31, up a bit from 9.39 two months previous. Latin America was again the exception, dropping to a P/CF of 5.55 from 6.12 in those months. Otherwise, the world was marginally more expensive from an equity perspective.
A similar story holds true when slicing the world by return on equity. At the end of last year, the world's equities changed hands at a 14.27 ROE, up a notch from 14.02 in October. Once again, Latin America bucked the trend, posting an ROE of 17.81 at 2006's close, down from 19.7 on October 31.
An optimist might say that with valuations holding more or less steady in recent months, in spite of the strong returns on the year, all's well for confidently deploying money in global stocks. Indeed, there's lots of liquidity looking for a home, and a fair chunk of it is likely to gravitate to equities in 2007. Why not jump on the bandwagon and grab a share of the impressive past returns?
Talking about risk, by contrast, is either dismissed or submerged these days. But as history suggests, risk has a habit of returning with a vengeance when everybody's looking elsewhere.
We now return you to the bull market, already in progress....
January 9, 2007
CONSIDERING A YEAR OF SLOWER EARNINGS GROWTH
In case you haven't noticed, there's a bull market in stocks. Our particular interest in this essay is U.S. stocks, for which the S&P 500 is the oft-quoted benchmark. By that measure, the recent past has been good if not spectacular.
Through yesterday, the S&P 500's total return for the past year is a nifty 12%, comfortably above the long-term average of around 10%. For the past three years, the annualized total return isn't quite as strong, but tidy nonetheless at 9.7% a year, according to Morningtar.com.
The market's rise has been warranted based on the surge in corporate profitability, which has of course translated into earnings growth. In fact, the earnings growth has been extraordinary. As outlined this morning by Bob Doll, chief investment officer for Blackrock, S&P 500 earnings have advanced at a double-digit pace for each year starting in 2002. Once the final numbers are in for 2006, Doll believes that S&P operating earnings will climb by 18%, he explained today at a press conference in New York, where yours truly was in attendance.
"Earnings have gone up faster than the stock market since 2002," Doll observed. As a result, the price-earnings ratio on equities has been flat to declining in recent years.
All of which seems to suggest that U.S. stocks are reasonably valued, if not undervalued. Doll, for one, is optimistic about equity returns for 2007, in part because the valuation levels on stocks look reasonably alluring, at least by Doll's reckoning. In an accompanying press release tied to this morning's festivities, Doll said that "price-to-earnings ratios for the S&P 500 Index are now at their lowest levels in 12 years. In our opinion, the second half of the bull market will most likely be fueled by expanding valuations, with price/earnings ratios expanding for the first time in six years."
Perhaps, although we're inclined to raise a question or two about what comes next for stocks. Let's start with the outlook for earnings in 2007. Using Mr. Doll's numbers, this year will witness a sharp slowdown in earnings growth for the S&P 500 relative to the recent past. Blackrock's estimate for this year calls for a 5% rise in S&P earnings, or less than a third of 2006's estimated 18% gain. The long-term average rise in earnings is 7%, according to Doll's handout.
The downshift in earnings momentum coincides with slower economic growth. U.S. GDP will rise by 2.4% this year, down from 3.3% for 2006, Blackrock forecasts.
The question that weighs on us: How will Mr. Market react to the earnings downshift? Yes, we know that continued growth at this stage of the economic cycle is impressive. But if the stock market rose by only slightly more than its long-term average return with a backdrop of extraordinary earnings growth, how will the crowd react when earnings roll in at a below-average pace?
One might wonder if the stock market is prepared for the earnings future that awaits. As Doll noted, bottom-up analysts collectively figure that S&P earnings will advance by 9-10% this year. That's almost twice as much as top-down analysts and Blackrock predict. The gap, Doll told us, isn't unusual: bottom-up analysts are typically more optimistic than top-down strategists.
In any case, the general outlook for slower earnings growth we speak of is no secret. Most investment strategists have been advising that 2007 will bring a substantially slower rate of growth in corporate earnings. Logic suggests no less. As any student of economic history knows, corporate earnings overall can't growth faster than the economy for very long. The 2002-2006 experience has been the exception to the rule. Something approaching normal awaits in 2007 and beyond for earnings growth. If so, what does that imply for equity returns? We don't have an answer today, but we have our suspicions.
January 8, 2007
WAGES TAKE WING
There are an infinite number of trends for Mr. Market to consider, and here's one more: wages are rising at a pace considerably faster than inflation. In fact, the trend has been around for a while. The question: what does it mean?
But first, the numbers. The Labor Department last week reported that average weekly earnings rose 4.5% in December on a seasonally adjusted basis--more than twice the inflation rate of 2.0% over the past year, as reported in November.
The rate of increase in wages is hardly new. Courtesy of number-crunching from NoSpinForecast.com, it's clear that the 12-month rate of change in earnings has been moving skyward for some time. Indeed, the last time that wages were growing a more than 4% annually was in the late-1990s.
With wages growing materially faster than inflation, now's a good time ask (again) is wages contribute to inflation? Economic theory in recent decades suggests the answer is "no." Inflation is a monetary phenomenon and so the buck stops (figuratively and literally) at the desk of the central banks. If inflation finds a head of steam, it is only because the Federal Reserve (and its counterparts around the world) was asleep at the switch.
In theory, rising wages won't increase inflation because an attentive central bank will nip the pricing pressure in the bud. Perhaps more importantly is the market's perception of the Fed's inflation-fighting credentials. If investors believe the Fed will do whatever's necessary to stop inflation, the threat will be contained. In a world where currency is backed by faith rather than gold, perceptions count for much.
By that standard, the bond market remains optimistic that the Fed will keep inflation contained. The fear premium that bond traders demanded in early 2006 when Ben Bernanke took over from Greenspan has retreated. The 10-year Treasury yield is only marginally higher now than when the maestro gave his last performance in January 2006.
Wages, as Bloomberg columnist Caroline wrote today, is a price reflecting the value of labor. Sometimes it rises, sometimes it falls, just as it does for any other commodity or service. Higher wages "can be a symptom of inflation, rising along with the prices of goods and services. But in terms of a driver of inflation, prices lead wages, not the other way around."
What, then, are we to conclude from the rise in wages? The labor market is tightening. Supply and demand has spoken. But while wages may not drive inflation, wage pressures may still influence the Fed's thinking on what constitutes an appropriate price for money.
If wages continue rising at a rate that's faster than inflation, can the Fed continue to keep interest rates steady? We know what economsts would say. How about the FOMC at the Fed? What do they think and, more importantly, how might it influence (informed or not) monetary decisions in 2007 given a labor market that seems inclined to tighten, thereby driving wages higher?
As a potential clue of what the monetary mavens are thinking, we'll quote from the Fed minutes for December 12: "...the possibility that the tightness of the labor market could lead to sustained upward pressure on nominal labor costs was viewed as an upside risk to the expected moderation in inflation."
So, we know that the Fed is keeping an eye on wage trends. One question investors might consider is whether the bond market is pricing in that publicly observed fact.
January 5, 2007
REASONS TO BE CHEERFUL...AGAIN
It's a new year and apparently it's time for a new debate. Or at least a rehash of a former debate that's been routinely embraced, dismissed and then embraced anew.
We find ourselves in the embracing-anew phase in terms of the thankless task of trying to figure out where the economy's headed. This morning's latest from the Labor Department on the employment picture is the source of our conundrum today. Unemployment remained steady at a low 4.5% in December as the pace of job growth for nonfarm payrolls picked up slightly to 167,000 last month.
Consider the monthly change in payrolls for the last few years, as per our chart below. Is this the profile of an economy headed for a material slowdown or worse? A casual reading of the trend might pause before giving a definitive answer. And for good reason. Employment trends are no trivial factor in driving the economy.
If Joe Sixpack and his friends are employed, the odds are diminished that they'll rethink their spending habits, which of late has been one of spending more rather than less. What's more, today's employment report shows that wages continue to rise, with private-sector average hourly earnings in December edging up to $17.04 from $16.96 the month before and from $16.81 in the third quarter.
All this may come as something of a shock to the bond market, which has been predicting economic softness as opposed to strength. The yield on the 10-year Treasury has been in decline in the new year, dipping close to 4.60% in intraday trading yesterday, down from the recently high of 4.71% on December 29. Back in the summer, the 10-year changed hands at 5.0%.
The stock market is arguably more in tune with the message imparted in today's employment report. The S&P 500 has been climbing steadily, almost mechanically since August. The sideways trading for much of December may give way to more buying after traders digest today's news.
The notion that the economy may prove to be stronger than the bond market expects found support earlier this week in the news for the ISM Manufacturing index, which last month reversed its November slump, suggesting that resilience is alive and well.
The real question is how the Federal Reserve interprets today's employment picture. The FOMC meets again at the end of this month. The Fed funds futures market continues to anticipate that policymakers will keep rates steady at 5.25%, and there's not much deviation from that view in this market for the immediate future.
This much, at least, seems clear: ours continues to be period of transition, casting shadows and clouds on what comes next. The consensus view is unclear, meaning that any one data point can reorder perceptions by more than a little. Betting the ranch on any particular outcome looks increasingly imprudent for the moment. Tomorrow, of course, is another day.
January 4, 2007
The broad asset classes maintained a bullish front last year, as we noted on Tuesday, and the trend held true among for equity sectors.
Breaking the S&P 500 into its 10 sectors reveals that 2006 was a winning year across the board for large-cap equities. As our tables below document, gains were easy find last year, no matter the sector.
The bottom performer in 2006 was healthcare, which delivered a relatively mild 5.8% price gain, or less than half of the S&P 500's price change last year. The top performer was telecom services, which displaced energy, which was the leader for both 2004 and 2005.
Expecting that 2007 will again deliver gains in every sector may be pushing it, however. Earnings growth is expected to slow this year relative to the recent past. While that poses no great inherent challenge, it does mark a downshift in momentum. The question is how investors react to the downshift?
For a sense of the perception challenge that awaits, consider the outlook for S&P 500 sector earnings for 2006's fourth quarter and how that compares to the full year projections. In nine of the ten sectors, the fourth-quarter projected earnings growth rate is lower than for the full year's forecast, according to a Zack's report published last month. Translated: the big earnings-growth momentum is slowing. By the time first-quarter numbers are published, the cooling relative to the recent past will be even more pronounced.
History suggests that investors are heavily influenced by the trends in the recent past, which has been kind to equity owners. When the trend shifts, perceptions can be altered, sometimes radically, depending on how long the previous trend has been rolling and how far animal passions have run. The danger, in short, isn't a slowdown in earnings. Rather, it's the potential for an over-reaction by Mr. Market, who's been known to go to extremes at times.
January 3, 2007
CORE EQUITY ETFs
In the January issue of Wealth Manager, your editor reviews the expanding list of ETFs in the core domestic-equity space. As students of the booming ETF market know, the menu is getting longer by the week. For the details on our tour of core, along with a recent inventory of the offerings, read on....
January 2, 2007
FOUR IN A ROW
U.S. markets are closed today to mark the death of President Ford, but the lack of trading doesn't dim the optimism that infuses a review of 2006 performance among the major asset classes. As our table below reminds, last year was a very good year.
Very good here is defined by positive performance across the board. As we've written previously, it's rare that all the major asset classes deliver gains within a given calendar year. Or, at least, it used to be rare. Bull markets have become standard operating procedure since 2003, although no one should confuse a trend with a reordering of the laws of money and finance.
No doubt such negative opining will fall on deaf ears in the new year. Throwing money at any or all of the asset classes has been a win-win endeavor, and recent history dominates wetware relative to the lessons of time.
Still, at the risk of being dismissed, we remind that bull markets as far as the eye can see haven't always been the standard for perception. Asset allocation may have once meant never having to say you're sorry, but it typically required suffering a setback in some corner of the portfolio.
No longer. For the fourth year running, red ink has been absent for the major asset classes.
For those who think this is the new, natural state of affairs in the capital markets, we salute you for your unbridled optimism. We don't share your particular strain of optimism, but it's impressive nonetheless. Indeed, it takes a special mindset to think that bear markets have been banished to the ether. To be sure, bulls within a given asset class are always thinking that the fun can run on longer, only find disappointment eventually. Extending such confidence to multiple asset classes simultaneously elevates hope to unprecedented heights.
Where might disappointment reveal itself in 2007? There are some early hints, based on December's stumbles. As the table above shows, red ink showed up in five asset classes last month. Yes, in any given month, there are bound to be setbacks, and it's unclear if the red ink of December offers clues about full-year 2007 performance. But after four straight years of bull markets in everything, the warning signs are increasingly ominous, wherever and however they appear.
Although we're not inclined to make predictions, we'll go out on a limb and forecast that 2007 will not deliver a fifth straight year of gains in all the major asset classes. Something will stumble this year; perhaps more than one asset class. It's simply too much to ask of the financial gods for another 12 months of profits across the investment spectrum.
It is a truism of investment risk that the threat rises as the perception of danger recedes. By that standard, it's time to question the notion that all's right with the world. At some point this year, one or more rebalancing opportunities will avail themselves to a degree that's been absent since 2003. Repricing risk, in other words, will again move to center stage. Taking advantage of that occasion demands holding an overweighted position in cash. Fear, in short, is déclassé, as it always is when its rival emotion is in overdrive.