Monthly Outlook: May 2021 

The Kentucky Derby is run on the first Saturday of May every year. It’s the most exciting two minutes in sports, some say. Picking the winner is difficult even for horse racing experts. The pre-race odds tell us who the favorite is, but it’s still a horse race. The favorite horse only wins 35% of the time. Investing is even harder, in some ways. Investing is like picking winners from a field of thousands of contestants that can go forward, backward, or sideways. But unlike horse racing, we can change our bets, change our investment selection and allocation, at any time during the race. And that, makes all the difference.

To build lasting wealth, we must do more than just assemble a portfolio of fast running investments. We need to balance the goal of making it with the necessity of keeping it. What is wealth? It’s stored up spending, really. You can use debt to bring forward spending from the future. There’s a lot of that going on today at every level. Government, businesses, and individuals are all leveraged to the max. Government uses debt for stimulus checks and infrastructure, businesses use debt to buy back their stock, and individuals use debt for houses, cars, college, and everything else their hearts desire right now! Those who have extra money or are disciplined enough to balance spending today with spending tomorrow, save. You then want to make sure that your savings keep up (or more) with what you could buy today.  To make the most of your savings, the investor needs to ask, what’s going up the most? How much to invest in stocks, bonds, real estate, commodities, etc.? Portfolio management requires the constant analysis of relative performance.

Markets are Rotating, Portfolios Need to Rotate, Too

Many money managers start with analysis of historical returns and volatility of broad investable asset classes. Then they build model portfolios that blend stocks, bonds, and cash that are expected to meet investors’ very long-term goals. That’s how the industry comes up with 80%/20% stock/bond portfolios for “aggressive growth investors” or a 50%/50% stock/bond portfolio for “conservative growth” investors. Managers build that model portfolio and hold through all the ups and downs. The investor is told to accept the volatility and remember the 30-year average returns. That’s just not realistic and it’s certainly not optimal. There are times when stocks outperform bonds and vice versa. We think portfolios should be actively managed to tilt toward the better performing assets to maximize growth and reduce downside risk.

Which Markets are the “Fastest Horse” Today?

For most of the past four years, the US Large Growth and Technology market has been the best performing market in the world. That changed in 2021 and Value stocks are now outperforming Growth stocks.  Financials, Industrials, and Energy are beating Technology. Similarly, US stocks have outperformed International stocks for years. But as the Federal Reserve prints more and more money, the relative value of international stocks is rising. Stocks continue to outperform bonds but that isn’t always the case. In 2001 and 2008, bonds easily beat stocks. Today, within the bond market, short term bonds are relatively outperforming long term bonds. Lastly, everyone knows that cash or money market funds pay next to 0%. Almost every market is beating cash today. But there are short periods of time when cash outperforms everything else. That will happen again.

This is the Worst Time to Buy & Hold

The only thing I would buy & hold today is an active allocation investment strategy. Valuations are so high today that a buy & hold strategy is almost certain to deliver mediocre 10-year returns and with a lot of stress. We constantly monitor about 25 global markets and compare relative strength. We’re always comparing “this market” to “that market.” Then we tilt the portfolios by investing more in the best performing markets. Critically, we include Cash as one of our market options. If that becomes the best alternative, we’ll buy Cash. Today, Value > Growth, US stocks > Int’l stocks, Short-term bonds > Long-term bonds. Having a flexible asset allocation allows us to build wealth, and keep it. It’s how we win the race.