For much of the year, beginning in January when the stock market had its worst start of a new year in history, we’ve been asked periodically why our portfolios haven’t been materially more defensive. The question has arisen at other times during the year, such as in aftermath of the UK’s “Brexit” vote, an event that temporarily took the market lower because of fear and uncertainty, but did not change the fundamentals. Now, some are wondering if the economic expansion could be getting long in the tooth.
Add to that the cable news chorus that, from time to time, warns investors that the next bear market is right around the corner (cable news pundits have called about five of the last two recessions).
And yet, here we sit, at or near all-time highs in equities.
For us, it’s a pretty straightforward proposition, thanks to the Astor Economic Index®, our proprietary, data-driven guidepost that allows us to determine, in real time, the direction and strength of the U.S. economy. Thanks to this “now-cast,” we are able to aggregate a variety of data into a single value, which we compare to historical levels and historical averages to determine whether we believe the economy is expanding or contracting and to what degree of strength or weakness.
The AEI is our answer to “the” question we believe is foremost on investors’ minds: What is the current state of the economy and its implications for exposure to risk assets?
As a robust aggregation of what is occurring across the $17 trillion U.S. economy, the AEI is our guide for determining risk asset allocation. Research shows that when the economy is growing, it is productive to hold risk assets (i.e. equities); when the economy is contracting, risk assets should be reduced. This is not prognostication—it’s now-casting, to capture the current state of the economy.
Since the economy turned the corner after the last recession—whether measured by the National Bureau of Economic Research (NBER), the Astor Economic Index®, or even your own “gut feel” of when things got better after the 2008-2009 financial crisis—the economy has been growing. As the AEI chart (above) illustrates, there have been points during this recovery when economic growth has been faster or slower. But at no time since the recovery has the AEI suggested that the expected return on risk assets was negative.
Not that there haven’t been some times of concern, when caution seemed prudent, such as the 2011 debt ceiling crisis and fears of a U.S. government default. But once those clouds cleared, downturns proved temporary and the financial news media’s repeated calls for a bear market were only head fakes.
The caveat, of course, is that some times are riskier than others; from time to time some assets and sectors do better than others. For example, earlier this year a slower pace of economic growth (but growth, nonetheless) suggested that we reduce beta somewhat in our portfolios, which we did.
Nonetheless, as the AEI chart shows from 2012 to the present, generally speaking risk exposure to risk assets (equities) has paid off, with the exception of a quarter or two. Our data-driven, fundamental approach, however, doesn’t attempt to capture short-term moves, quarter to quarter. As we tell clients, our goal is to generate solid, long-term returns, but our discipline is focused mainly on mitigating risk and protecting the downside. We attempt to give investors what we call “a smoother ride” through the cycles. Interestingly, this theme was featured in a recent Wall Street Journal’s report on the desire of investors for “peace of mind” by controlling volatility. When investors know what they want they can pursue their investment goals accordingly. A fundamentally-driven, macroeconomics-based approach, we believe, is the key to staying disciplined in the pursuit of those investment objectives.
For now, the AEI tells us to stay the course with exposure to risk assets. One day, presumably, that will change—and when it does, we will act accordingly.
All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.
The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.