Scalper1 News
Summary For the past couple of weeks, I have been reading extensively through the 2016 investment outlooks of top-quality research firms. In this article, I will present six themes that I gleaned from my research. Ultimately, I will assign weightings and present The ETF Monkey 2016 Model Portfolio. In future articles, I will develop ETF-based portfolios based on this model, from three major providers. First of all, I would like to begin with a word of thanks to my 366 followers, and 88 real-time followers. When I started my work here on Seeking Alpha using the pseudonym ETF Monkey, I had a total of 59 followers from my previous work and, I believe, only five or six real-time followers. I am deeply grateful to each and every one of you! This past July 1, I presented The ETF Monkey Vanguard Core Portfolio . The portfolio features what I call “beautiful simplicity,” demonstrating that one can build a low-cost, greatly diversified portfolio with as few as three ETFs. Like many other authors here on Seeking Alpha, I would now like to offer my thoughts on a model portfolio for 2016. I have spent a fair amount of time over the past couple of weeks reviewing various 2016 outlooks from a variety of quality sources; including PIMCO , BlackRock (NYSE: BLK ), Wells Fargo (NYSE: WFC ), Vanguard , Bank of America Merrill Lynch (NYSE: BAC ), Goldman Sachs (NYSE: GS ), Deloitte , and AAII . Needless to say, there is a great deal of divergent thought represented in these outlooks. And, certainly, I was not able to carefully read every last word of every outlook. What I focused on, though, was looking for common themes ; ideas that ran through more than one outlook. From that research, I have developed The ETF Monkey Model 2016 Portfolio . In this article, I will feature the main themes that struck me, as well as outline what I believe to be a model asset allocation for the year ahead. But I am also going to go a step further. I will follow up this “theoretical” work in future articles by selecting what I believe to be the best ETFs to use to actually construct this portfolio. I will do so for three different major providers: Vanguard, Fidelity (featuring iShares funds), and Charles Schwab (NYSE: SCHW ). The idea will be that investors who use these three providers can select commission-free ETFs both to build and subsequently rebalance their portfolios, all without incurring excess trading costs. Finally, using closing prices on December 31, 2015, I will both build and track each version moving forward to get some idea of comparative performance. I will also track all of them against the performance of The ETF Monkey Vanguard Core Portfolio. As readers may surmise, I have a two-fold goal from this exercise: To attempt to determine how much of a difference selecting ETFs from different providers makes if one starts from the same basic place. For example, in some cases, one provider may offer a better expense ratio for a certain component or asset class. How much difference does this make over time? To attempt to determine if this “ideal” 2016 portfolio is able to outperform the rather basic ETF Monkey Vanguard Core Portfolio, built very simply using three core Vanguard ETFs and using the weighting derived from the Vanguard Target Retirement 2035 Fund ; designed for an investor approximately 20 years from retirement. Let’s begin by taking an overall look at the big picture. The Big Picture As they say, “a picture is worth a thousand words.” With that in mind, I am going to open this section, called “The Big Picture,” by very literally presenting three big pictures. Here’s the first one, from PIMCO’s 2016 outlook, featuring 10-Year return estimates across several asset classes: (click to enlarge) Take a quick look across those projections, particularly the asset classes highlighted in red. You will see each of those show up in some fashion in the themes I will develop as the article progresses. Here is our second big picture. This one is from BlackRock’s 2016 Outlook. (click to enlarge) Similar to the first picture, look at the boxes and arrows, and what they indicate. You may already be able to discern some common themes simply by comparing these two graphics. Finally, using the S&P 500 index to represent the U.S. stocks and various Vanguard ETFs as proxies for other averages, have a look at how various markets have performed over the most recent two-year period. In the graph below, the Vanguard FTSE Developed Markets ETF ( VEA) represents developed markets as an overall group, the Vanguard FTSE Emerging Markets ETF ( VWO) represents emerging markets, and the Vanguard FTSE Europe ETF ( VGK) represents Europe specifically. ^GSPC data by YCharts With that overview, we now come to six investment themes gleaned from my research, which I believe will benefit investors in 2016. Theme #1: The “New Neutral” Some investors may recognize the phrase “new neutral” as being from PIMCO, and you would be correct. Here is a brief quote concerning its overall expectations: At the center of our New Neutral thesis is the belief that even as central banks raise rates, they will do so slowly and prudently… We don’t foresee an inflation problem… Low interest rates and moderate inflation together support a muted but prolonged business cycle, and we believe this combination helps to sustain current asset valuations. We would argue that the tailwind from ever-lower policy rates… is largely past us. Moreover, current valuations… are likely to constrain potential returns going forward. Therefore investors must adjust to a world where returns on asset classes and the paradigm for constructing optimal portfolios over the next five years are unlikely to resemble those of the last five or even 30 years. Echoing similar sentiments, BlackRock’s 2016 Outlook offers the following: The wave of central bank liquidity looks to have crested. Monetary policy may take a back seat to other cycles for the first time since the financial crisis. Finally, this from Vanguard’s 2016 Investment Outlook: The U.S. Federal Reserve is likely to pursue a “dovish tightening” cycle that removes some of the unprecedented accommodation exercised due to the “exigent circumstances” of the global financial crisis. In our view, there is a high likelihood of an extended pause in interest rates at, say, 1%, that opens the door for balance-sheet normalization and leaves the inflation-adjusted federal funds rate negative through 2017. Essentially, this theme posits a period of muted results as we move forward. At the same time, while the tailwind provided by the current interest rate environment is almost surely behind us, the Fed is expected to move slowly with respect to raising interest rates, allowing some maintenance of current asset valuations. Theme #2: Better Opportunities May Exist Outside the U.S. Our second theme takes note of the historically high valuations currently reflected in the U.S. market, and the fact that one may find better returns in 2016 by being willing to look beyond the shores of the United States. For this section, we will think very broadly in terms of the entire international segment, both with respect to developed and emerging markets. I will feature two specific targets in later sections. The BlackRock 2016 Outlook features this theme extremely succinctly: Valuations appear to have leapt ahead of the business cycle in many markets, especially in the U.S. We have essentially been borrowing returns from the future. PIMCO’s outlook appears to agree with this thesis, as explained here: In developed markets, to name a few examples, we believe global equities outside of the U.S. offer better forward return potential than those within. Across credit sectors we see superior opportunities in European financial and U.S. housing sectors. With respect to government debt, we generally find inflation-linked securities more attractive than their nominal counterparts. Finally, from Vanguard: The growth outlook for developed markets, on the other hand, remains modest, but steady. As a result, the developed economies of the United States and Europe should contribute their highest relative percentage to global growth in nearly two decades. Based on this theme, I will include a relatively modest allocation for domestic (U.S.) equities and what may be considered to be a somewhat aggressive allocation in developed international markets in my model portfolio for 2016. Theme #3: Consider Europe The BlackRock 2016 Outlook specifically features Europe as a candidate for consideration. It writes: For example, we suggest building exposure to cheaper developed markets where monetary policy is unambiguously expansionary and valuations are more forgiving, such as in Europe and Japan. This is backed up by a helpful table comparing the valuation levels of U.S. securities against their European counterparts, both in various sectors as well as overall. (click to enlarge) PIMCO also features this in its outlook, noting many of the same characteristics. Looking around the globe, European equities appear attractive over the secular horizon. In addition to the broader developments discussed, the trend toward increased dividend payout and a higher equity risk premium provide a good backdrop for superior returns. European equities offer high levels of earnings yields and valuations are lower relative to history. In its Q4 Global Economic Outlook , after frankly discussing the challenges Europe faces from the slowing Chinese economy, Deloitte offers the following observation: Despite this very volatile, challenging environment, the Eurozone has continued its recovery. In fact, this may be seen as evidence that the recovery can now weather external shocks. In this way, the Eurozone has left the “stall-speed-phase” of the recovery behind, in which it was highly vulnerable to external turbulences. Finally, with regard to the related outlook for monetary policy in Europe, Vanguard notes: Elsewhere, further monetary stimulus is highly likely. The European Central Bank and Bank of Japan are both likely to pursue additional quantitative easing and, as we noted in our 2015 outlook, are unlikely to raise rates this decade. Based on this theme, in addition to my overall allocation in developed international markets, I will include a small additional allocation dedicated specifically to Europe in my model portfolio for 2016. Theme #4: A Measured Gamble on Emerging Markets This particular item may be the most high-risk, high-reward venture within the portfolio. The picture in emerging markets is far from clear. In my research, I found comments ranging from great concern to cautious optimism. Clearly, the impact from China may be acutely felt in these economies, so could the effects of the Fed increasing interest rates in the U.S. Perhaps, the clearest example of a positive comment I saw comes from PIMCO. It acknowledges the risks but, at the same time, offers some possible reasons for optimism: Turning to emerging markets (EM), we believe that on average these sectors should outperform comparable developed market sectors over the secular horizon, but are likely to do so with higher volatility and other risks that must be considered. As in the developed markets, lower yields have been a tremendous supporter of performance for EM assets following the financial crisis. However, in the past few years, emerging markets have gone through numerous challenges that have led to generally disappointing performance. Lower growth, lower commodity prices, weak exports and a strong U.S. dollar recently have been serious headwinds. The silver lining of the recent challenges, however, is that EM assets generally offer more favorable starting valuations. EM growth, which is expected to be higher than in developed markets, also helps valuations appear attractive. Add in the higher level of investments and productivity enhancements, and we have a favorable backdrop for attractive secular returns from emerging markets. Bank of America/Merrill Lynch offers this somewhat positive view: Start of emerging markets recovery – For the first time since 2010, average annual growth in emerging markets should begin rising to 4.3 percent in 2016 from 4.0 percent in 2015. Excluding China, growth should pick up to 3.1 percent in 2016 from 2.6 percent in 2015. About three-quarters of emerging market economies could show signs of recovery by the middle of 2016, whereas Brazil could contract further to -3.5 percent as it struggles to climb out of recession. Investment likely will become the key driver of the emerging market recovery. Asset price returns of roughly 2.7 percent for external sovereign debt, 2.5 to 3.5 percent for emerging market corporate debt, and 1.0 percent for local currency debt are expected in 2016. In contrast, Vanguard cautions: Most significantly, the high-growth “goldilocks” era enjoyed by many emerging markets over the past 15 years is over. Indeed, we anticipate “sustained fragility” for global trade and manufacturing, given China’s ongoing rebalancing and until structural, business-model adjustment occurs across emerging markets. We do not anticipate a Chinese recession in the near term, but China’s investment slowdown represents the greatest downside risk. Finally, BlackRock summarizes their view of emerging markets this way: Investor sentiment is near record lows, according to the latest BofA Merrill Lynch Global Fund Manager Survey, which we view as a good contrarian indicator. Assets also are generally cheap… The same is true for companies that derive a large part of their revenues from the emerging world including China. They have severely underperformed in the past year… and now offer selected value. We are nibbling at EM assets, but not enough to fill our overall underweights. I have been watching this segment closely for some time. Given the weak pricing of this asset class, which can be graphed as being basically flat since 2009, this is going to be the biggest gamble in my model portfolio for 2016. I am going to assign it a relatively aggressive weighting of 7.5%. Theme #5: Consider TIPS As A Preferred Alternative To Bonds This theme actually caught me by surprise as I went through my research. With the prospects for inflation remaining low, TIPS have fallen somewhat out of favor of late. Interestingly, this is commented on favorably in BlackRock’s outlook: Among government bonds, only Treasury Inflation Protected Securities (TIPS) have gotten cheaper. Ten-year TIPS are effectively pricing in an average annual inflation rate of just 1.25% measured in personal consumption expenditures (PCE) terms, well below the Fed’s 2% target. Even 30-year inflation expectations have been dragged down by the oil price slump, pricing in annual PCE inflation of 1.45%. Can inflation really stay so low for so long? This sets a low bar for TIPS to outperform nominal bonds. PIMCO appears to agree with this view. Here are its comments: For the core government bond anchor in a multi-asset portfolio, we like U.S. TIPS (Treasury Inflation-Protected Securities). Not only are they an asset carrying only one risk, real rate risk (unlike nominal government bonds that carry both real rate and inflation risks), but we also view them as attractively valued relative to nominal bonds. The large amount of slack in the global economy over the past few years as well as the recent commodity price correction have resulted not only in a drop in inflation expectations (and fears of possible deflation until recently), but also in a near complete removal of inflation risk premium from the markets. Under these conditions, we think TIPS are an attractive choice for the core fixed income component of a multi-asset portfolio. Based on this theme, my allocation to TIPS will actually exceed my generic allocation to bonds in my model portfolio for 2016. In addition, my allocation to bonds will be right on the middle of the market, in terms of duration. I hope to balance the amount of income provided with overall downside risk. Theme #6: Include Some Exposure To REITs A truly diversified portfolio includes exposure to both multiple geographies as well as multiple asset classes. This can include some form of exposure to real assets . In the graphic from PIMCO featured towards the outset of this article, you will notice that, in addition to TIPS, the greatest forecasted returns over the next 10 years were featured as coming from REITs. I was happy to see this, as I include a measured weighting in REITs in my personal portfolio. What makes REITs intriguing to me is that they represent an asset class that is sort of partway between stocks and bonds. Their unique tax structure requires that they pay out at least 90% of their earnings in the form of dividends, making them in some ways similar to a bond. At the same time, a well-run REIT can also benefit from capital gains, as the value of the properties they hold can increase over time, making them in some ways similar to a stock. Based on this theme, in addition to my overall allocation for bonds and TIPS, I will include a modest additional allocation dedicated specifically to REITs in my model portfolio for 2016. Putting It All Together: The ETF Monkey 2016 Model Portfolio Based on everything that preceded it, here are the official asset allocations for The ETF Monkey 2016 Model Portfolio: Asset Class Weighting (%) Comments Domestic Stocks (General) 30.00 See Theme #2. Domestic Stocks (High Dividend) 5.00 I am going to include one ETF providing minor targeted exposure to high-yield securities, to help generate income for the portfolio. Overall, this brings my domestic stock allocation to 35%. Foreign Stocks – Developed 20.00 See Theme #2. Foreign Stocks – Emerging 7.50 See Theme #4. Foreign Stocks – Europe 5.00 See Theme #3. TIPS 15.00 See Theme #5. Bonds 10.00 REITS 7.50 See Theme #6. TOTAL 100.00 As I mentioned in the outset, look for further articles to follow. In these, I will reveal my choices for the specific ETFs with which to build this portfolio, from three different providers; Vanguard, Fidelity (with iShares funds), and Charles Schwab. Until then, I thank you for reading, and wish you… Happy Investing! Authors Note: If you like my work, I would be deeply indebted, and highly grateful, if you could be sure to follow me here on Seeking Alpha, as well as feature my work to friends, colleagues and/or relatives who may be interested in the subject matter. Other than the time you invest to read, there is no other cost for the work that I do. Your support will enable me to continue my efforts. Scalper1 News
Scalper1 News