Due to demand from our investors this is the first of a continual series of ‘commentary’ posts.  In these, we take our monthly fund factsheet commentary and extend on it with some charts and other data sources that are curently affecting our thinking and also our underlying asset class universe. Our portfolio allocation depends purely on Momentum calculated in a quantitative/mechanical way, however prices always move due to some underlying cause. No one really knows the cause but it’s fun to guess!

The first few days of February saw a bit of rebalancing in our defensive portfolio. We now have almost 25% in equities from Emerging Markets, with the remaining allocation still in short and medium term US treasuries. Glancing at the fundamentals for Emerging Market Equities: they are historically cheap however this isn’t a deciding factor – we strictly follow only our momentum model to enter. The Inflation linked bond allocation was reduced and replaced with EM equities, since the latter’s long term momentum score gave us a statistically significant signal to enter.

Below is the latest asset class score table that we use for portfolio allocation in the Passive Allocator strategy

Volatility across risk assets has fallen considerably however this current rally does seem overbought in our opinion. This could well be a bear market rally, which makes us comfortable in still holding a majority of the portfolio in defensive Treasuries. Having said that we are closely watching US and EAFE equities, Corporate bonds and even Gold. These are all on the brink of a positive long term momentum signal. Given the drastic shift in the US FED’s tone from Hawkish to Dovish, animal spirits seem to be drawn in again. There is a lot of cash on the side lines too – this swathe of liquidity could fuel equity indices higher for the year. Our return for the month was a steady 0.65% while our 60/40 global stock/bond benchmark raced ahead clocking almost 2.8%. After dodging most of the recent downside fall, we are happy to wait on the sidelines for this rally to play out. If risk assets take a turn for the worst again, our portfolio will be safe.


EEM vs SPY ratio

Looking back to the 2000s, emerging markets were all the rage. They were highly valued, and then they were not. Currently the ratio between US and EM equities is at cycle lows. While this need not be a mean reverting series, there is a clear valuation gap between the two.


US, EUzone and Asia Pacific Economic Surprise Index

Although economic surprise indices for all major regions including EMs are at yearly lows. We are clearly late in a business cycle, with the ubiquitous 2s-10s treasury yield curve also almost inverted. Without some external stimulus or monetary boost to the global economy, this current volatility crash looks almost eerie. Is it the proverbial eye before the real storm?


US 2s10s yield curve overlayed on S&P500

Forget the argument about whether inverted yield curves bring about recessions or not ( they do in our opinion ), but let’s just look at the SPX price data during past yield curve flattenings. As soon as the flattening ends and turns into violent steepening, the SPX index has crashed. Which one is the leading indicator here is still not proven, but we can conclude that going “all in” equities when the yield curve is flat, seems like financial suicide.

Happy Investing
The PA team