Feb 20, 201202:02 PMBlog: Alaska's Eye on Wall Street
BLOG: Eye on Wall Street: Markets off to a good start in 2012
We are starting 2012 on the right foot as the global equity markets are off to their best start in 18 years, according to Bloomberg. Better U.S. economic data, a round of liquidity from global central banks (including the Fed), and signs of improvement in Europe have been catalysts. It also looks like inflation is cooling here and abroad. The accompanying table details the results of the markets in January.
The following is the second half of APCM’s annual 2012 Market Review and Outlook.
“Economists set themselves too easy a task if in tempestuous seasons they can only tell us that when the storm is past, the ocean will be flat again.” — John Maynard Keynes
With all due respect to the Maynard Keynes, as far as investment strategy goes, a lot does depend on your time horizon and willingness to ride out market storms. The idea that investors can jump back and forth based on a macro outlook and consistently make money has never appealed to us. That’s a marketing pitch, not a solid investment approach. And by the way, when the storm has long passed the markets will be way, way higher.
What we can do is try and understand asset pricing and see if there is enough of a cushion built into current pricing and risks. And then construct diversified portfolios that can withstand inclement market weather for the long term. If you are worried about volatility and may need cash soon, stay in short term low yielding investments. It’s as simple as that. There are no free lunches.
With that in mind…
Treasury bonds are unattractive, but do serve as an anchor in the wind during stormy weather (such as 2011). They are an insurance policy and about the only thing that goes up in a risk off environment. But with interest rates at historic lows (cash at 0 and 2 percent on 10-year Treasuries) the hurdle rate for stocks is very low for investors with a reasonable time horizon.
U.S. stocks trade at a 12x multiple of earnings and earnings yields at 8% are well above bond yields. We think stocks will beat bonds in most scenarios (other than a crisis) and have a modest tilt to equities. Large cap stocks in particular should fare well. Earnings won’t be gangbusters like last year, but 5 percent gains would be just fine.
International stocks are even cheaper than U.S. stocks, but they are cheap for a reason (particularly European names). Diversification is a good thing but we are cautious on Europe. A break up of the euro would be bad and it could happen. Best to keep some powder dry here. Favor emerging market equities over developed country markets.
While treasury bonds are rich, most other sectors of the bond market aren’t. Spreads have widened out and corporates and high quality CMBS remain our choice in the fixed income markets. Within bond portfolios we are a bit short our benchmarks. That has been painful given the steep yield curve and decline in rates, but how low can they go? Admittedly short rates should stay low for a while given the Federal Reserve’s anxiety over the economy and unemployment picture. But the overall risk/reward tradeoff says to us “get your yield through spread product not duration.”
Municipal bonds are attractive. But, less Federal spending equals less revenue to state and local governments and maybe higher taxes. We favor state GO’s and essential service revenue bonds and avoid localities overly dependent on property taxes.
We have been through a very difficult market environment over the past several years. This year will be challenging as well.
Jeff Pantages, CFA, is the chief investment officer for Alaska Permanent Capital Management, a $2 billion investment management and advisory firm located Anchorage.
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