In the last month of 2019, we see another firm stride higher for major equity indices lead by the usual suspect: US Technology. It’s been three months of steady gains in risk assets, being displayed by an uncanny high Sharpe ratio hike in the evergreen “northeast quadrant” of price charts (arguably the most favourite quadrant for statistically minded students of the market). Japan, Europe, and US large-cap equity indices have entered the troika of heady price rises – Low volatility, High Correlation, and Positive Momentum. These moves can go on longer than rational fact-checkers can attribute valid reasons to it. Mechanical portfolio strategies like ours keep the emotion at bay and ensure participation in these strong rallies. Said rallies caused our fund to gain 0.77% for the month, thus ending the year up 5.2%. We still hold around 25% in intermediate and long term bonds, plus approximately 10% in global real estate. These rate-sensitive allocations have been dragging over the very recent past but their long term momentum is still intact, albeit at lower scores compared to Equity indices. Such price movement then begs the question: has the bond market top been formed? The multi-decade bull market in bonds indeed continued in the first half of 2019; however, most bond indices have retreated and corrected since August. Looking at the macro picture – the US Fed made an about-turn from rate hikes to reductions to now a possible pause for 2020. Trade tensions although currently subdued, are not fully resolved. This doesn’t seem like an issue that will go away during the current US presidency. Speaking of the latter, we just cannot bet that the current low volatility environment – both implied and realized – will last for very long, given the highly charged upcoming US election. We brace ourselves for an exciting 2020 ahead.

SPX Index 2019 price and momentum chart. Source: Bloomberg

The S&P500 index is still the leader when it comes to low vol uptrending price action. Not just in the equity space, many other broad asset classes haven’t kept up with the SPX over this past decade, and 2019 was yet another stride upwards of near 30% albeit from a deep low at the end of 2018. This decade has pretty much been easy pickings for Beta, Passive Investing, Buy and hold or any other term that describes “lazy” investing. We don’t think being lazy in the world of investing is necessarily a bad thing! For us, however, we use passive vehicles as tools to make a better portfolio, jigsaw pieces to an ever-changing macro picture. We do appreciate the efficiency of these ingenious Beta vehicles called ETFs.

LQD ETF (Investment Grade Corporate Bonds) 2019 price and momentum chart. Source: Bloomberg

On the other side of the multiasset chessboard, fixed income assets have paused their own relentless uptrend. Q4 2019 has indeed witnessed a sideways consolidation and uptick in yields for major bond indices. We harbour a belief that the Bond Market, more often than not, gets things right. Bond price signalling should not be ignored by other participants. In this case, can we glean that ultra-low interest rates are a thing of the past and Inflation might be gearing up to hit headlines in 2020? Too early to call but at least there is more room on the upside for bond prices to rise in case 2020 sees some major Risk-Off sentiment.

MSCI ACWI index earnings yield vs. US 10Year Govt Bond yield. Source Bloomberg

On a further, deeper look at the above two charts, one needs to decide which of the two major asset classes are more expensive on a relative basis. (on an absolute basis both are no doubt historically expensive). Turns out when including the entire global equity complex of MSCI All Country World Index, equities still exhibit a healthy risk premium over fixed income. With an earnings yield of near 5%, they sit much higher than US treasury 10-year yields which are at decade lows of 1.87%.  We’ve already established above that equities still have strength Momentum-wise. Subjectively one is just a little concerned about the low volatility environment. The logical conclusion would be that 2020 could have a good number of rebalancings for our portfolio if Vol gets elevated and trends change.

We would like to thank our Investors for a great 2019; here’s to a healthy and super-profitable 2020!

Happy Investing
PA Fund Team