Trading is not a game of exacts. Perfectionists need not apply. Markets are made up of many irration...
Ablin's Asset Allocations
10/08/2004 12:00 am EST
Jack Ablin establishes investment policy for Harris Private Bank. He takes a "top-down" approach, by looking at major global trends to determine over- and undervalued asset classes to isolate markets that are expected to outperform. Here's his macro-outlook.
"We are global macro-allocators, which means we tend to take a top down view on various markets – looking for undervalued asset classes or where markets are overvalued. It’s frustrating that the spread between the best performing asset classes to the worst performing asset classes is extremely narrow. In fact, year to date, the spread in returns is about 12%. When you look at an average year, that spread typically ranges from 45% to 70%. So the opportunity to make a lot of money by going long or short markets is somewhat subdued, which is probably the reason that hedge fund returns will be pretty lackluster.
"I’m in the defensive camp. I tend to believe the bond market here, and not the Fed so much. It would seem to me that a lot of the better elements driving the stock market are behind us. We look at earnings growth. While it will still come in at around 14% this quarter, that’s down from 28% at the beginning of the year. We look at the slope of the yield curve and the relationship between short term to intermediate term Treasuries and that’s flattened. Generally the stock market likes the yield curve to be steep. Liquidity is pretty much neutral.
"That said, the equity market, fundamentally is fairly valued, any maybe slightly bullish. If you are in the market, I wouldn’t worry that the bottom is going to fall out. I think we’re at fair value. In fact, I could make a case that the market could sustain a 10-year Treasury rate as high as 5% without stumbling. However, the best metrics on the stock market are probably behind us. As for specific asset allocation recommendations, I’d note that my time frame is generally 12 months and within that horizon, I like several exchange-traded funds (ETFs) and a commodity play:
"The Dow Jones Select Dividend Index (DVY NYSE) is related to a theme that has been working this year, in an environment with flat to subdued returns. In this environment, capturing as much dividend income as possible is the right thing to do. Within the S&P 500, energy is fairly valued compared to the rest of the market. But it still has a lot of favorable momentum and reasonable psychology behind it. Health care is actually cheap, trading at a discount to the S&P. We suggest the Energy SPDR (XLE AMEX) and the Health Care SPDR (XLV AMEX)."
"The Morgan Stanley Emerging Markets Index (EEM AMEX) is a valuation play. Emerging market economies are certainly stronger. Also, the credit shape and balance sheets of many of these countries and their respective companies are in pretty strong shape. We’ve seen many more upgrades than downgrades within this sector. And valuations relative to our market, while not as cheap as they were, are still relatively cheap. The p/e multiples of many of these markets trade at about 60% of the p/e of our market.
"PIMCO Commodity Real Return Fund (PCRAX ) is a proxy for the Dow Jones AIG index. Unfortunately, you can’t sit and determine if commodities are expense or cheap – there is no fundamental value for them. But what you can do is look at a favorable environment for commodities. The key here is that as long as short-term interest rates are set below the rate of inflation, then we have a favorable environment for commodities. The Fed has kept short-term interest rates below the rate of inflation for about 2 years and it appears they will keep them there. If you look at the breakeven expectation on inflation based on the TIPS spread to Treasuries, it’s about 2.6%, so if you start to see the Fed funds rate go substantially above the 2.6% level, you may want to scale back or sell this commodity fund."
The key risk-on and off drivers today are the same – U.S. politics, global growth, other centr...