In today’s Barron’s magazine there is an interview with Dennis Stattman of BlackRock Global Allocation called “Mixing It Up in an Uncertain World”. In this article he discusses his world view and his views on asset allocation. It is a great article and highly recommended.
Dennis starts by explaining that our current situation is odd.
The first thing you have to realize… is that it is an artificial environment because of extraordinary government measures, both on the fiscal and monetary side… but our portfolio strategy has to take into account with what is going on with our unit of account, the US dollar.
How much time do people spend thinking about how their equities and assets (home values) are going to change when the government can no longer prop up the economy, and what the impact on the US dollar will be at that time? And when we have to start paying back that debt we incurred during these extraordinary days? And if they have thought about it, what have they DONE about it?
In the US with the ups and down in equity prices from the 2008-9 debacle to where we are today it is easy to forget that much of this recovery in stock prices is due to the fact that the government bailed out many institutions that would have otherwise failed, loaded the country up with debt that has to be repaid in the future, and taken our interest rates down to zero which has enormous benefits to many types of US companies.
So we have to realize we are in an artificial environment, characterized by temporary and extreme governmental measures. We don’t know when those will end. But we do know that they can have a profound impact on asset prices and profits.
In response to a question about diversifying into areas other than equities and debt (commodities and foreign equities and debt, from a US perspective, he has another great pithy summary:
It isn’t surprising that this category (commodities) is growing… it reflects the frankly dismal job that the most popular category, equity-only mutual funds, have done, as shown by the dismal results they have delivered to investors over long periods of time… the idea that somebody can buy six different US stock funds and somehow achieve useful diversification just isn’t an effective idea. It never was a good idea, and now it has been proved wrong.
I remember about 15 or so years ago when a friend asked me how to allocate their 401(k) account that they were setting up at their new company and I said just go “100% equities” because that has been proven to have the highest returns in the long run. Not only did I give that advice back in the day (and it was great advice based on my limited track record and the big bull run of the 80’s and 90’s as interest rates plummeted) but I took that advice, too. Live and learn.
When asked what his company’s plan was, Stattman said the following:
First of all, we follow some simple basic rules: Diversify, buy low, sell high, have a plan.
While people talk about a diversified asset portfolio, they don’t always put front in center the “buy low, sell high” component. Even if you invest in passive vehicles, such as ETF’s or mutual funds, you have to have an “active mindset” due to the bubbles and “hundred year events” that continue to hit our markets, meaning of course that these events aren’t really hundred year types. In a recent Bloomberg article simply titled “Arizona Land Sells for 8% of Price Calpers Group Paid at Peak” the first paragraph sums it all up with
A 10,200-acre (4,100-hectare) desert site in Arizona sold for $32.5 million this week, five years after a group with investors including the California Public Employees’ Retirement System paid $400 million for the land.
When you have bubbles where asset prices, whether they are stocks, bonds, commodities, currencies or even art, appreciate wildly, you need to be prepared for the crash and you want to either sell at the peak (figuring it out is hard, granted) and then buy from the ashes. For something like land which can’t go bankrupt to decline 92% in five years is an amazing summary of the irrational exuberance behind the recent asset bubble, and a lesson to heed going forward on a permanent basis.
Stattman also discusses the blurring of the boundaries between equity and debt asset classes. He says that there are times when the debt asset class has opportunities (and risks) that are more typically found on the equity side. He describes convertible bonds, high yield bonds and emerging country debt especially coming out of restructuring. To lump these opportunities under “bonds” is inaccurate; they need to be viewed as investing opportunities in their own right.
If you just had a traditional “rule of thumb” you’d say 60% equities and 40% bonds. However, the new dimension is the percentage of assets denominated in US dollars. Stattman’s portfolio was 54.6% USD, and he said this was 5.4% below their internal benchmark (obviously it is 60%).
While investors have been putting money into foreign stock funds for years and even buying individual stocks either through ADR’s or through the foreign bourses directly, it is new (for me, at least) to look at the whole portfolio including bonds and cash through the prism of underlying currency denomination.
He has some interesting thoughts on the super-low yields currently being offered by long term debt.
A 10 year Treasury Inflation Protected Security (TIPS) recently had a real yield of 0.77%. In real terms and compounded, that would suggest that an investor who buys that TIPS turns $1 into $1.08, compounded and in real terms, after 10 years. I surely hope that doesn’t represent the good end of investor outcomes, because if it does, we are all going to be in one heck of a sorry state. So there isn’t much real yield in bond prices.
That analysis shows the double-edged side of these low rates; not only are they low rates today, the “compounding” effect of interest on your interest and principal goes down to practically nothing in actual dollar terms under these conditions.
And back to equities…
My overall view on equities is that they are the best game in town. But that doesn’t necessarily mean that they are a good game. The reason we think they are the best game in town is that you can simply buy stocks at very attractive valuations… of the biggest 50 companies in the S&P 500… there are 16 companies selling at single-digit P/E’s. At the same time, the 10-year Treasury was recently yielding about 3.07%, which is the equivalent of a P&E of 32 1/2. So compared with bonds, stocks are a screaming buy.
And he ends with another warning about the US dollar and the reserve currencies:
I definitely want to counsel people to be very cautious about having too much exposure to nominal dollar-denominated long term fixed-income assets… we are overweight a broad set of Asian currencies, and we are overweight some of the resource currencies such as the Real in Brazil. And we are underweight the big three currencies: the dollar, the Euro, and the Yen.
To mitigate some of this currency risk, his portfolio has a position in gold. He also notes that with low interest rates the opportunity cost of holding gold, which provides no returns in the form of dividends or interest and has holding costs to boot, is smaller.
Cross posted at Chicago Boyz