In these posts, we take our monthly fund factsheet commentary and extend on it with some charts & thoughts that are affecting our thinking and also our underlying asset class universe. Passive Allocator’s 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!

March was a steady month once again with our fund making 1.07% return while the benchmark clocked in 0.88%. There were no extraordinary price movements in any of our underlying asset classes – things were as ‘calm’ as an investor could hope for. (Is this the calm before a storm?). Our portfolio is still overweight US Treasuries, however there were some positive momentum signals in March that made us rebalance into a variety of ‘Risk On’ positions ranging from US Large Cap, US Tech, EM equity and also a small portion into Global Real Estate. Our underlying ETF list is now upto 10 holdings versus only 4-5 ETFs late last year. Momentum and Volatility- our two factors that dictate rebalancing – have changed considerably since then. Our fund looks more like a multi-asset portfolio but it’s still more defensive than average. Fundamentally speaking, the US yield curve inverted across many vital parts of the curve in March. More importantly, the financial media picked this up in a big way and started doing what they do best: blow it out of proportion! Recession calls are now increasing, with the price of both short and long term US and UK Govt bonds showing solid gains last month (which is why we gained in our fund). Is the bond market telling the equity space something? There is an old saying that out of all asset classes, the bond market sees recessions first and bids up in price much before others. Plus the fact that the US FED has turned markedly dovish, we feel it will be a good year for bonds.

Passive Allocator momentum & Volatility score table for Mar 2019

One can see marked reduction in volatility across the asset universe. More importantly, US Equities momentum is now looking upwards. Besides US equities, an interesting asset class to show momentum strength was Investment Grade Credit. We have added some ETFs tracking the Markit iBoxx USD Liquid Investment Grade Index. With the FED & ECB making a massive U-turn in rhetoric over the past few months, high quality bonds doesnt seem like the worst place to be in.

Markit iBoxx USD Liquid Investment Grade Index – daily line chart

Now that everyone knows the US yield curve is inverted, which in turn is a harbinger of economic recessions, is it time to sell everything and go into cash? Maybe not. After all, the yield curve could be early (at least 12 months early) in signalling weakness. This chart below shows the US 2yr -10yr yield curve along with the FED Funds rate. This current curve situation looks like an early signal, or maybe even a false alarm?

US 2s10s Yield Curve over FED funds rate. Source: Bloomberg Analytics

We are trying to look at this situation from a game theory lens. Every market participant is watching this flatness and waiting. This could be one reason why the recent rally in equities is actually one of the least participated ones ( as seen by comparative ETF investment flows over Q1 2019). There is lot of cash on the side lines. The “pain trade” is actually higher for equities rather than lower in our humble opinion.

PA Team