This Week's Message: Core Allocation Update

I was initially planning on making this week's message all about credit markets, but find myself in need of some extra time to sit with our current core mix of assets and determine to what extent, if any, rapidly evolving conditions warrant a bit of tweaking. 

Therefore, while you'll no doubt be hearing plenty from me in coming weeks on corporate credit (although we've I believe effectively set the stage for you over the past few months), for this week's main message I thought I'd touch on our allocation process, then graph for you our core positions' performance year-to-date.

First and foremost, we have a have a thesis around macro conditions. As you know, for us, this is an ongoing, dynamic, ever-evolving process. Each week I share with you some of the data we crunch, along with my perspective, in our "Macro Update." Click here for the most recent.

Then I essentially line up asset classes and equity sectors, develop a macro thesis around each individually, then determine how much, if any, of each to include in our core mix.

During unusually difficult (risky) setups, we'll also develop options strategies to provide additional downside protection.

Having at the beginning of this year rotated to a core mix that better reflects what remains our macro thesis, my present task is to rethink my idiosyncratic theses, asset class by asset class, and determine if recent developments warrant any adjustment on an individual position basis. Of course, this is indeed an ongoing process, which explains the several trade confirmations you've received so far this year. So here's how each position looks thus far in 2020 compared to the MSCI All World Stock Index (bold blue line). The % next to each category (in bold) represents its weighting in our overall mix. The % next to each position represents its weighting within its category.

Click each graph below to enlarge...

Currencies (20%):

FXB Pound (20%) (green)
FXE Euro (21.25%) (purple)
FXY Yen (15%) (white)
GLD Gold (43.75%) (orange)




Alternatives (7.5%):

SJB Short (inverse) Junk Bonds (100%) (white)




Developed Foreign Equities (22.5%):

FEZ Eurozone (50%) (purple)
VPL Asia Pacific (20%) (red)
EWG Germany (15%) (white)
EWQ France (15%) (green)

Emerging Foreign Equities (5%):

RSX Russia (10%) (green)
VWO EM Index (90%) (white)




US Equities (45%):

XLF Financials (5%) (blue)
KBE Banks (2.5%) (orange)
XLB Materials (8%) (red)
XLI Industrials (8%) (grey)
XLE Energy (4%) (orange)
XLK Tech (5%) (blue)
VOX Communications (5%) (green)
VZ Verizon (2%) (purple)
T AT&T (2%) (purple)
XLP Consumer Staples (20%) (white)
XLV Healthcare (7.5%) (green)
XLU Utilities (20%) (yellow)
XLRE Real Estate Inv Trusts (11%) (brown)

The good stuff:

• Our currency positions (which includes gold) have all handily outperformed stocks so far this year. 
• Our alternative position (inverse junk bonds) has performed exceptionally well to this point.
• The top three performing sector exposures happen to be our top three % weightings: Utilities, REITs and Staples.

Neutral: 

• Our emerging markets index has ever so slightly outperformed the broad market (well, let's call it a virtual tie).

The bad stuff:

• Our developed foreign equity exposures have all underperformed the broad market; with our largest exposure, the Eurozone Index ETF, the worst of the lot.
• Our more cyclical exposures -- industrials, materials, financials, banks and energy -- have underperformed the broad market (energy and banks substantially). 
• Russia, which we've already cut to a very small position (0.5% of the overall mix) is underperforming markedly.

In summary: We're pleased that the assets we added specifically to produce less correlation (vs our previous mix) to an all-out bull market in stocks -- currencies, gold and the inverse junk bond ETF -- have performed markedly better than stocks in general so far this year. The fact that our three largest positions (comprising 51% of our US equity exposure), which are defensive in nature, are currently outperforming the broad market validates our present macro thesis.

With regard to our underperforming (some markedly) positions, while short-term price movement is a minor consideration in terms of whether or not to add, or remove, a position, it indeed speaks to a position's relationship to prevailing macro conditions. We may determine that the factors leading to a marked decline in price are ephemeral and could, therefore, inspire us to even add to the holding -- or we may determine that our thesis around it is simply wrong and, therefore, dump it altogether; which -- along with testing potential reformulations of our options hedging strategy -- is what we're presently assessing, and will be acting on shortly.

In closing: Overall, 65% of our core positions have outperformed the broader stock market on a year-to-date basis (the majority of them notably). Factor in the huge performance of our current options hedge, thus far, and our fully allocated (unhindered by legacy positions held for tax reasons) client portfolios have averaged only mid single-digit year-to-date declines, while the broad market is rapidly approaching bear market territory.