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.