"Kee" Points with Jim Kee, Ph.D.


  • Quick Take
  • Asset Class Performance Lessons


Quick Take

With U.S. and developed-world stock market indices up strongly this year (so far), my quick take is that the market cares a great deal about U.S./China relations, which seem to be making progress, and very little about Donald Trump/Nancy Pelosi relations, which do not. However, that could change with time. I have mentioned previously that markets tend to shrug off government shutdowns, because they usually just result in rescheduled or delayed spending. But a prolonged shutdown can have a negative impact to the extent it interferes with the wealth-creating activities of production and exchange. This can happen in a variety of ways because many industries rely on government agencies for approvals, permits, loans, and other regulatory activities (i.e. airport security) that are a regular part of business. Former SEC commissioner Joseph Grundfest used the analogy of holding one’s breath - you can do it for a little while without any damage, but at some point the effects dobecome damaging. That is the sand-in-the gears argument for ending prolonged shutdowns, and I agree with it. Globally, the IMF has downgraded its expectations for growth (albeit from 3.7% to 3.5%), citing trade concerns and their impact on global activity, particularly Europe. “The bad news,” writes Asian Times economist David Goldman, “has a name and an address, which is Germany.” That made me chuckle. Germany grew about 1.5% in 2018, and is a big exporter highly sensitive to global trade. The sooner we see progress on trade policy and on the government shutdown the better!

 


Asset Class Performance Lessons

I just received one of those “investor’s periodic tables” from one of our data providers, Crandall, Pierce & Co., which shows the multi-year performance of different asset classes. Before the 2008 global financial crisis, quantitative analysis indicated that if you had to choose just a single asset allocation, you would be better off choosing 100% value (no growth), and mostly small cap (Financial Times). In fact, one innovative researcher argued that taking the best of both of those worlds - small cap value - and putting all of your equity exposure in that, would allow you to allocate a majority of the portfolio to bonds and still earn the overall return of the market (with the juiced-up small cap value allocation) but with much less risk. Well, looking at the past ten years, guess which U.S. equity class (large cap, mid cap, small cap, value, growth) did the worst? Yep, small cap value. Did anything do worse than small cap value? Yes, international stocks including emerging market stocks. Anything worse than those two? Yes, hedge funds. Worse than hedge funds? Yes, commodities did worse than hedge funds. Now, if you go back ten years many strategists were advocating a strong allocation to commodities because they had done so well after China joined the World Trade Organization in 2002 (i.e. the “commodities” super-cycle). Hedge funds were also hot. Burton Malkiel, the famed academic author of “A Random Walk Down Wall Street,” advocated a 50% allocation to international stocks, the majority (30%) to emerging markets (although Matthews India, which he advocated, did extremely well). Another (Larry Swedroe) advocated small cap, value, and emerging markets exposure with no pure growth (Kiplinger). The point here, really, is one that Jeanie Wyatt made in her recent quarterly letter. You cannot time these asset classes and you should not try. By maintaining exposure to growth and value, small cap andlarge cap (and mid cap), and even international, you should – over a full cycle – experience the broad market gains with less volatility.