As CEO of Advisor Perspectives, one of the great privileges I enjoy is the opportunity to interview thought leaders in the investment industry. Since one of the primary goals of our publication is to provide unbiased and accurate investment advice, we seek out those individuals with a proven track record; their collective wisdom is invaluable.
With the unparalleled challenges our economy faces and the extreme dislocations in the financial markets, no decision is more important than proper asset allocation. Many of the experts we spoke with over the last year foresaw the collapse of the equity markets in 2008. Heeding their advice would have dramatically improved the performance of virtually any portfolio.
So what do the experts say about the markets for 2009? What would a consensus asset allocation look like? One of those rare individuals who clearly foresaw the collapse of the housing market and the resulting impact on the financial markets was Nouriel Roubini. Professor of economics and international business at NYU's Stern School of Business, Roubini also runs the Web site RGE Monitor, which provides economic analysis and forecasts. Although Roubini's pessimistic forecasts earned him the nickname Dr. Doom, his reputation has grown steadily as virtually all of his forecasts--starting in 2006--have become reality. Roubini's style is very direct; he says investors should stay away from risky assets and the equity markets in 2009. He advises avoiding the corporate debt and commodities markets, and staying liquid in either short- or long-term U.S. government bonds.
Mohammed El-Erian, the co-CIO and co-CEO of PIMCO and former manager of the Harvard endowment, has a similar view. In mid-December, he warned investors not to automatically rebalance as the value of the equity component of their portfolios declined. "Investors should go up the capital structure," he said, and capture the attractive returns offered in the investment-grade bond market. El-Erian, like Roubini, cautioned investors against taking too much risk.
Data from the Advisor Perspectives (AP) universe shows that advisors who manage assets for high-net-worth investors, heeded El-Erian's advice. With the steep decline in the U.S. equity markets in the fourth quarter of 2008, equity allocations in the AP universe dropped from 60.4% to 56%, while fixed income allocations increased from 26.7% to 30.4%. Virtually all of these changes were explained by market movements; advisors did not proactively change allocations or rebalance.
Another individual who foresaw the crisis in the financial markets is historian Niall Ferguson, professor of finance at the Harvard Business School and author of the best-selling book The Ascent of Money. Ferguson echoes the sentiments above, and says investors should look outside the U.S. for growth. Over a four-to five-year horizon, he favors China, as well as Brazil and Chile.
Horace "Woody" Brock is founder and president of Strategic Economic Decisions, consultants to institutional investors. For five years, Brock has warned clients about the perils of the U.S. equity markets. The danger is not over, Brock says, adding that claims that equity markets are "fairly valued," are nonsense. In December, he said, "...investors are rightly disenchanted with the fact that stocks have lost them money over the past decade. There is nothing like growing disenchantment with past returns to drive valuations lower."
Another source of low expectations for U.S. equity markets is P/E ratios based on trailing 10-year earnings. Yale professor Robert Shiller and GMO Chairman Jeremy Grantham advocate this methodology. As I noted in last month's column, these P/E ratios are still above their historical averages and nowhere near the levels at which bull markets typically begin.
"Traditional asset allocation is fatigued and will no longer produce the same returns," says El-Erian. Investors should not be lulled into thinking that the traditional 60/40 mix or the "buy and hold" philosophy will be optimal in 2009, which promises to be every bit as disruptive as 2008. The equity markets may not tumble as they did in 2008, but right now--these and other experts say--the perceived risk is priced into the fixed income markets. With investment-grade yields at near record spreads, the equity risk premium has disappeared, and bond yields are far more attractive now than equity returns.
An ultra-conservative investor could follow Roubini's advice and hold only U.S. Treasury debt. But that could backfire, as Treasury yields are at record low levels. A more prudent portfolio would combine TIPS and diversified investment-grade corporate debt holdings, a nice fit with
El-Erian's forecasts.
None of these experts advocates taking a position in an inverse or levered inverse fund/ETF. Roubini still holds 100% of his retirement assets in equities, as he believes that the long-term outlook for equities is positive. So a fair dose of skepticism is justified. Nonetheless, if you don't want to heed the advice of these experts, you can allocate a substantial portion of your portfolio to U.S. equities for the coming year.
Robert Huebscher, rhuebscher@advisorperspectives.com, is CEO of Advisor Perspectives (www.advisorperspectives.com), a free online database and weekly newsletter for wealth managers and financial advisors.
