Labeling a particular stretch of time ordinary, extraordinary or just plain weird is one of those tasks that fall under the heading of subjective analysis. But we’ll risk it and proclaim that ours is an extraordinary moment in time, perhaps even weird.
We speak from a strategic perspective on the subject of asset allocation. As we’ve noted before, bull markets are in blossom everywhere, in virtually every asset class. While that’s good news for calculating the profits on former investments, it raises doubts about what’s coming.
Before we go any further, let’s admit that timing the markets isn’t our forte. In fact, we’re skeptical that any one harbors such a talent, at least when measured over a business cycle or two. Our preference is one of rebalancing based on the signals Mr. Market dispenses. If asset A is up 10% over the past year and asset B is down 10%, we’re inclined to take profits from A to feed B. Yes, that’s a dangerous game with individual securities, but it carries an impressive pedigree when dealing exclusively in asset classes. The reason: asset classes don’t go bust, which is more than we say for individual securities.
But there’s always a glitch, even in the best-laid plans. The last few years have provided strategic-minded investors with a conundrum. Indeed, if everything is up, then it stands to reason that nothing is down. As a result, the prudent course for rebalancing is less than obvious and fraught with more than the usual dosage or risk.
Consider that all of the following indices posted gains in each of the three calendar years for 2003-2005.
* Russell 3000 (U.S. stocks)
* MSCI EAFE $ (Foreign developed-market stocks)
* MSCI EM $ (Emerging market stocks)
* Lehman Bros. Aggregate (U.S. bonds)
* Credit Suisse High Yield (U.S. junk bonds)
* DJ-AIG Commodity (commodities)
* DJ Wilshire REIT (REITs)
Previous to 2003-2005, the last year that all seven asset classes were winners was 1996, which followed a less-than-perfect 1995. So, yes, sometimes the bulls are running the show across the board, but it’s a rare event and it almost never lasts for very long, unlike the current run.
Suffice to say, across-the-board bull markets should be seen for what they are: a gift from the financial gods, but one that comes with a price tag at the end of the rainbow. After 1996’s perfection, 1997 dispensed losses to emerging markets and commodities, with MSCI EM $ shedding 13.5% that year and DJ-AIG losing 3.4%. In fact, in 1998, both of those indices continued retreating at an accelerating pace and the selling spilled over to DJ Wilshire REIT, which tumbled 17% that year.
So where does that leave us in 2006? Worried…and prepared to take advantage of any attutide adjustment in the capital markets.
No, we don’t know what’s in store for the asset classes in 2007, but we have our suspicions. Those suspicions are informed by the fact that all of the seven asset classes listed above are firmly in the black for 2006 through the end of November. For the moment, one could reasonable expect that all seven asset classes could again post gains this year when the final tallies are written in stone on December 31.
If so, that will make the fourth year in a row that the major asset classes all show calendar-year advances. Now that’s extraordinary and arguably weird and, if history can be trusted, more than a little risky. Then again, from the current vantage, some might say it’s the norm. Recent history has an overly large influence on investment thinking. But for our money, the trend of recent vintage lives on borrowed time, which is why we continue to favor the eighth asset class, and the only one that’s supposed to show gains (however slight) in each and every calendar year: cash.