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Change of Seasons Report: September 30th, 2018

Fall has arrived!  


There have been some interesting cross currents this year that have presented us with some challenges and opportunities. We have been expecting a low return year after last year’s gains. The equity rally has been focused in US markets and more specifically in technology, while most bond market indexes are down on the year. Despite the long-term argument for diversification, 2018 has not been a great year for a diversified portfolio.  


As we have been writing about, we think there is an opportunity to rotate out of Growth stocks into Value. There has been a huge outperformance cycle for Growth so far this year (see the green line relative to the blue line in the chart below), but we are now in the late stages of the economic cycle which would project some headwinds for this relationship. 


As a category, Value stocks—normally painted as boring companies in staid industries with a bit of yield—are setting up for some excellent outperformance relative to growth over the next 3-5 years. Growth names have been the major driver of index gains in the United States. At the end of these cycles many times there is one last thrust, where growth outpaces value over a short period of time before seeing the relationship move back in line. We think that time may be at hand, and as such, we have tilted our equity models towards this Value theme. 


Asset Allocation Changes  


We continually evaluate the risk and reward of global markets. As you know we have 3 sets of models within each of your asset allocations: Equity, Blended Asset, and Income.  


The risk profile of each category goes from high to low. Equities are the riskiest (and highest return) and Income is the least risky (and lowest return).  


Our Blended Asset category is in the middle of the road from a risk and return perspective. Within those models we dynamically allocate between stocks, bonds, alternative investments, real estate, and commodities. We are making some allocation changes to the Blended Asset portfolio mix based on some developing opportunities: 


1. We are reducing our exposure to World Stock indexes from 45% to 35%. This is the second cut to equities since late 2017. As a reminder, we were at a 70% allocation as recently as a year ago. We are seeing some typical late cycle sector rotations that indicate that volatility may be on the rise. As such, we want less capital at risk in stock indexes. 


2. We are maintaining our 25% weight to Alternatives / Commodities. We haven’t done much in the way of Alternatives, but we have held a steady overweight exposure to commodities starting in late 2017. This allocation will help cover unexpected inflation in the economy when both stocks and bonds tend to struggle.


 3. We are increasing our allocation to bonds to 25% from 15% in anticipation of an upcoming buy opportunity. We have been underweight bonds as the opportunity set has been narrow for our approach. Interest rates have backed recently, as broader bond indexes are now down over 2% YTD. While recent returns have suffered, we think there will be a good time to own high quality bonds at some point in the next year or so.  


Within our Income models we are taking our weight to High Yield down to 10% from the current 15%. We put high yield corporate bonds, emerging market bonds, convertibles, mortgages, and preferred stocks in this category. While performance in the riskier parts of the bond market has been decent of late, we see risks building underneath the surface. A flatter yield curve, less monetary accommodation from central banks, and less liquidity in bond markets, in general, could result in sharp losses in these sectors. 


To Sum It All Up  


Based on our research, data, and experience we think we are late in this economic cycle. Right now, the global economy is still growing, but financial conditions are tightening to the point where “accidents” tend to occur. In some ways the current situation is highly unique. In others, it is the same old, same old.  This movie has played out over and over throughout time. Markets move to excess, and then reverse. Rinse and repeat.


 I won’t call these forecasts, per se, but I will leave you with a few expectations. Some will sound familiar. 


1. Active equity strategies will outperform passive indexes over the next 3-5 years. Active almost always outperforms passive when volatility rises. Extrapolating current trends is generally a mistake with investments, the current out-performance run for passive included. 


2. Value stocks will outperform Growth stocks over a similar time-frame. See point #1. 


3. This one is fairly consensus, but global yield curves will invert in the next 6 months (long term rates below short-term rates). 


4. Commodities will continue to perform well as unexpected inflation starts to show up in a bigger way. 


5. Interest rates on risky bonds will be higher in a year than they are now. Riskier bonds are pricing for the status quo to continue. We think there is risk in that assumption. 


 Our way of dealing with all this uncertainty has always been—and will always be—our risk management philosophy. The secret to compounding wealth is not to hit it out of the park with investment performance, year in and year out, but to construct diversified portfolios that are more durable to multiple outcomes. Digging out of a performance hole is extremely punitive. Rather than attempting to forecast explicitly what will occur—and when—we take a disciplined approach that tries to avoid large drawdowns so that we can compound your money at a higher rate of return.  


As always thank you for trusting us with your hard-earned dollars. We are always here for you should you have any questions. 


Enhanced Wealth Management Service Package Offering  


On June 1, 2018, All Season Financial Advisor’s enhanced our Wealth Management Service offering by increasing the benefits available to our clients across the board. As a result of this enhancement, more of you are now eligible for our complete suite of integrated financial services which includes financial planning, annual tax prep, and estate planning services. To learn more about our comprehensive Wealth Management Service offering and to determine your eligibility for these services, please visit our website at https://allseasonfunds.com/our-services/wealth-management-packages or give us a call at (303) 837-1187.