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Just Thinking Out Loud

I have to admit, this emoji thing might have some legs.  I was bit resistant at first; dismissing it as nothing more than a cutesy teenager fad.  But I also had a flip phone until a few years ago and thought electric cars were Logan’s Run sci-fi.  Of course, pop culture acronyms are a first cousin to the emoji.  You name a slang expression and there is probably a phone (and fat finger) friendly abbreviation.  While my 87 year old mom might know what LOL means, it has a glut of more contemporary offspring.

For example: social Michelle suffers from a chronic case of FOMO.  And her once feral cat, Catherine, has eagerly adopted a YOLO[i] attitude.  So while those two spoon, I pace the dark, lonely hallways at night, accessing the financial landscape, gripped by TINA – There Is No Alternative.

I say this with respect to investment asset classes and their expected returns.  Thanks to central bank financial engineering, we are now in investment purgatory.  Stocks are now trading at relatively high historical valuations vs. growth rates. [ii]  Bonds look to be exhausted after a nearly 36 year bull run.  Outside of satisfying liquidity needs, cash is paying bupkis.  Real estate, dependent on the current, historically low interest rates, is probably due for a breather.   Currencies, commodities and precious metals’ volatility & complexity might be too unnerving for some.  So what’s left? Believe it or not: maybe all of the above.

It’s human nature to become fixated on whatever’s currently popular.  From an investment standpoint, this has been collectively US equities – the best performing asset class the past 5 years.  But this recency bias, can also distort our future judgement. “If it ain’t broke: don’t fix it” might be sound advice for plumbing but not so much for personal finance.  Market, economic & political conditions are dynamic; not stagnant.  Today’s environment is no exception – in fact, it might be even more extreme.

As a closet asset allocator, I believe true diversification is on the cusp of regaining its vigor.  And by diversification, I mean low correlating, asset classes within a portfolio – not owning 5 different stock mutual funds.  Adding multiple asset classes in relatively equal amounts can, in fact, stabilize returns and lower volatility – as measured by standard deviation.  See the attached 2015 Wells Fargo Table of Investment Returns.  Before you hit the delete button, give it a perusal – it’s interesting to see how different investments rise and fall year to year.  Previous darlings become present day dogs and vice versa.  {Note: commodities have been the worst performer each of the past 4 years}  The point of this is how difficult it would be to accurately forecast.  Hint: we can’t, so be guarded when you encounter absolute predictions. [iii]

I suspect we will shortly be entering a period of heightened volatility – based on seasonality, a heated presidential election and interest rate rhetoric.   Relatively docile markets like the past few years are very vulnerable to a ‘what if’ event.  Judiciously spreading your bets & holding a little extra cash may serve to buffer instability and also provide opportunistic buying power.  It may also help you sleep a little sounder.  But that’s JMHO.

[i] Carpe Diem’s dumbed down version

[ii] Birinyi Associates: S&P 2017 PE ratio: 25.  

[iii] Beware False Prophets, Fiscal Fitness, August 2016