The end of a year is always a good time to reflect on what just happened and try to take a guess as to what lies ahead. Coming off 2018 where nearly nothing worked in portfolios, this year has proven to be the exact opposite with all major asset classes posting positive returns through the end of November. Not only have the returns been positive, they have been exceptionally strong for both stocks and bonds.
As we look ahead, it is important to acknowledge the events of the past, but not rely on them for the future. Much like driving, it’s good to check the rearview mirror every now and then, but to get where you are going successfully you must look ahead.
On the fixed income front, long-term returns for bonds tend to match up pretty well with their yield to maturity. With the Federal Reserve hinting at no action, and coming off outsized returns in 2019, there are plenty of indicators that support bonds reverting to a return driven more by the income than price appreciation.
On the equity side, the story is a bit more mixed. Concerns of valuations creeping up are being offset by pockets of positive economic signals. That said, the story of the day tends to be outweighing stock fundamentals as the primary driver of near-term returns. This is a challenge to traditional data-driven decision making and will likely be a driver of continued bouts of short-term volatility ahead.
Future success for most investors will probably come from a combination of proper asset allocation and investors being as efficient as possible with each dollar invested. Proper asset allocation is not so much correctly guessing which asset class is next to be in vogue, but rather building a fortified base that positions portfolios to capture or defend regardless of what comes around the corner.
In a potential low return environment with no clear asset class looking particularly enticing, investors will need to take advantage of opportunities to get more out of their existing investments rather than abandoning their fortified asset allocation base. Adding more capital efficiency to a portfolio (i.e. via an overlay strategy) can provide the potential to achieve attractive returns in a low return environment without stretching the portfolio’s risk budget.
The truth is, we really don’t know what the future holds for any asset class. A combination of building a fortified asset allocation plan while incorporating measures to increase the efficiency of each dollar invested can help prepare a portfolio to defend capital should markets sour, without sacrificing return potential should they continue to run.