Expectation Gap | A Better New Normal
The idea behind asset allocation is simple: When one investment category struggles, it’s OK because that is offset by another category that is thriving. Not so in 2015. After embracing everything from treasuries to high-yield bonds and technology shares amid seven years of 0% interest rates, investors found themselves with nowhere to run at a time when the Federal Reserve’s campaign of stimulus drew to an end.
Will this be our new normal?
We’ll come back to that. It certainly has not been the norm in the past. Since 1995, practically every year has seen some asset class deliver returns exceeding 10%. According to Bianco Research, the S&P 500, 30-Year US Treasury bonds, 3-month Treasury bills, and the CRB Commodity Index make up the 4 most common asset classes investors consider when designing and allocation strategy.
So why didn’t anything work last year?
It could be that there are simply too many choices and alternatives within the four broad categories tracked by Bianco Research. According to the study, gains from the best performing assets had surpassed 10% in all but one year since 1995.
During the last 9 decades, 23 years, or a quarter of the time, at least one asset class returned more than 30%, and only four ended with gains of smaller than 4%. After all, this gave rise to our 2 most popular alternatives of ETFs (exchange traded funds) and Hedge Funds. According to Bloomberg, the Hedge Fund industry was headed for its worst annual performance since 2011, with Fund closures rising. ETFs have not fared much better. Many investors use ETFs to invest in different asset types as a way to diversify risk. Uncertainty over the timing of the Fed’s first interest rate increase in almost a decade and its potential impact on the economy weighed on the markets throughout 2015.
The Fed has finally broken that cycle by beginning policy normalization, and hopefully this will provide the markets with some clarification and resolve in a more solid direction. We finally have execution of a game plan in place. Will this change in game plan take shape over night? The performance of the financial markets so far this year are indicating that it will take some time. According to Michael Arone, chief investment strategist at State Street Global Advisors, “… if the market feels comfortable at the pace of which the Fed moves interest rates and the economy is recovering, risk assets like stocks as a category could perform well”.
I for one am very excited for this new normal. Investor expectations for stocks, bonds, and the ever growing list of new alternative products have been elevated by recent history. Last year may be a wake-up call to investors to perhaps lower their expectations about returns and pay more attention to the overall risk of their portfolio.