June 28, 2013
By Steve Blumenthal
This week, I discuss two relevant thoughts and first share a few thoughts on the recent spike in interest rates:
- Total Credit Market Debt is still too high
- The Tipping Point
The big headwind to growth remains debt, deficits and entitlements. At the same time the forward expected return for the overwhelmingly popular 60/40 mix is just 4.38% as of May 31, 2013. Here is the link. Today’s starting point of low dividends, low implied inflation and low interest rates are the low forward return drivers. 4.38% before an advisor fee compares poorly to the 14 decade average of 7.6%. Investors are expecting 8%. There is reason for concern.
Can the average investor stay the course? I have my doubts. Note the following from Reuters – June 26 – “Investors in mutual funds based in the United States pulled $7.97 billion out of bond funds in the latest week, marking the first three-week streak of outflows from the funds since August 2011, data from the Investment Company Institute showed on Wednesday”. Fear drives the unprepared from his plan. The big portfolio risk is in the bond exposure.
Unknown to most individual investors is the loss that exists in a rising rate environment. Should rates increase just 3%, the loss on that 40% in bonds is significant. Note the next chart was last updated on May 8, 2013 when the 10-year Treasury was at 1.77%.
The Single Biggest Portfolio Risk I See:
With a move up in rates from 1.77% on May 8 to nearly 2.77% last week (now 1.52%), the loss on the 10-year Treasury was -8.60%. No wonder the exodus from bonds as reported by Reuters was so big. Can your client say the course? Put a therapist’s couch in your office – they need you!
Total Credit Market Debt
Note here that when Total Credit Market Debts are “Debt High” growth slows. The analysis on this chart shows that when the debt load got well above the norm (data since 1951), GDP growth rates began to fall well below average.
Adding to this concern is that the government is borrowing like crazy. Debt is a headwind. Expect GDP growth to remain well below Wall Street and Government forecasts for some time to come.
PIMCO’s Bill Gross – The Tipping Point
Before I jump to Bill’s Tipping Point, I found the following quote by Mohamed El-Erian insightful, “From my perspective, it appears that the West is nearing the end of the era where central banks are able to impose stability on a still-inherently-unstable set of economic and financial fundamentals. Going forward, fundamentals (rather than financial engineering) will play a greater role in determining the level and correlation of asset prices. Should this indeed materialize, you should expect the current phase of generalized disruption to give way over time to greater differentiation.” (FinancialTimes)
Bill sees some value in rates today and caution for tomorrow. Here is the link to The Tipping Point.
Overall, I continue to conclude that a period of lower than hoped for returns is ahead for the popular 60/40 construction. Several storms remain and a few of them could be quite strong. However, there remains opportunity and a shift to include a broader set of return streams is important. I favor expanding the portfolio construction from two buckets to three (equities, fixed income and Tactical-Alternative). It can both enhance your portfolios’ forward return potential and it may reduce your risk experience along the way.
The principals of Modern Portfolio Theory are sound. 60/40 remains challenged. Expand the total portfolio construction to include some important risk diversifiers.
Call us if you would like us to evaluate your current portfolio mix. We’ll run it through our Portfolio Simulation Analysis and we can offer some ideas on how to enhance your current construction. Let me know if you’d like to learn more.
Today, I am in NYC for several business meetings and appearance on Fox Business News to share my thoughts on shifting the portfolio from 60/40 to 33/33/34. I went a little lighter on the makeup this time. Click here to take a look at the segment.
Have a great weekend,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
Philadelphia – King of Prussia, PA
steve@cmgwealth.com
610-989-9090 Phone
610-989-9092 Fax
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