Cyclical Asset Allocation Quarterly

Transcription

1 Global Investment Strategy Cyclical Asset Allocation Quarterly January 4, 2016 Our cyclical asset allocation process is based on a rolling three-year outlook which means that the Global Investment Strategy Committee evaluates how the portfolios are expected to perform over the next 36 months based on asset valuations as well as economic and market outlooks. This is different than a tactical or momentum-driven allocation process, which constantly adjusts to changing shortterm conditions. The cyclical approach is very much driven by fundamental valuations, which can lead to entering and exiting positions as potential opportunities arise. Over time, this approach may help avoid chasing unsustainable, wild market swings driven by fear and greed near the end of cyclical declines or advances. Overview» With our outlook for 2016 recently published, we look for another year of modest economic growth in the United States. Based on our analysis, we believe the U.S. economy will grow 2.6% this year. This compares to our 2015 growth estimate of 2.5%. Lackluster performance in a number of international economies has been a negative for many domestic companies with international operations. However, we look for improvement in the overall global economy this year.» We look for inflation to stay low based on historical comparisons but see the Consumer Price Index (CPI) coming in at 2% this year, well above last year s reading of approximately 0.5%. Remember, core Personal Consumption Expenditures (PCE) is the Federal Reserve s (Fed) preferred inflation gauge. Our central bankers are targeting a 2% level for PCE which is unlikely to occur this year. Our estimate for the CPI is far below the longer term average of approximately 4.4%.» Business and consumer confidence readings have been somewhat volatile this year but are currently holding near levels we consider good. Most of these indicators saw their recovery highs in the first half of We continue to expect business and consumer confidence to improve over the coming 12 months.» Our extended outlook suggests this cyclical bull market still has more room to run over the next couple of years. We continue to focus on those equity sectors more sensitive to the ebb and flow of the economy. However, earnings growth in 2015 was negatively affected by the Energy sector in a meaningful way. We look for earnings growth to be in the 6% to 7% range this year.» In terms of international equities, we remain cautious on the outlook for emerging markets. That caution is reflected in our cyclical models. Volatility will likely continue in the short term, especially if commodity prices do not stabilize. We are more optimistic in the nearer term when it comes to international developed country equities.» Interest rates will likely increase modestly as we move through Given our outlook for economic growth, we believe the yield on the 10-year Treasury note will land in the 2.5% to 3.0% range at the end of this year. We are taking a more balanced approach to fixed income allocations at the present time. As a result, we recommend that investors adjust their portfolios to be largely in line with their strategic fixed income allocations. Page 1 of 7

2 Economic and market considerations Based on current economic policy and market conditions, the Global Investment Strategy Committee has used the following themes in its asset allocation decisions: Debt markets The divergence in global central bank policies is starting to take hold after the recent move to lift shortterm domestic interest rates by the Fed. We look for the European Central Bank (ECB), the Bank of Japan (BOJ) and the People s Bank of China (PBOC) as well as a host of other major central banks to increase the amount of stimulus they are providing to their respective slow-growth, low inflation economies. However, even though their policies may diverge, all of the major central banks, including the Fed, should still be providing huge amounts of liquidity and easy money to their economies in coming years. We believe the American economy will post modest growth in the quarters ahead. Therefore, it makes sense that the Fed would begin the long process of normalizing interest rates. This process will continue over the next couple of years at least. Note that the fed funds target rate has been sitting at virtually zero since In our opinion, two further hikes in the second half of 2016 are likely. The goal of the Fed throughout this recovery has been to keep interest rates low and provide liquidity to the economy. Boosting the value of assets such as stocks and housing were also goals. These goals, in our opinion, have largely been met. The pace of economic growth in the United States should increase slightly this year compared to last. We see full year 2016 growth coming in at 2.6%. The yield on the 10-year Treasury note currently stands at approximately 2.25%. We are looking for interest rates to rise slowly over the coming year or two. We expect the yield on the 10-year Treasury note to finish 2016 in the 2.5% to 3% range. For longer-dated maturities, we are looking for the yield on the 30-year Treasury bond to end the year in the 3.0% to 3.5% range. If interest rates appear ready to increase over the next few years, some investors may question the need to own any bonds at all. Remember, as interest rates rise, bond prices tend to fall. But we encourage investors to consider the total return of this asset class. Bonds pay interest and this potentially helps to offset negative price movement. In addition, we expect a well-diversified fixed income portfolio to outperform cash alternative allocations over time. Bonds can also help diversify a portfolio as the future is quite frequently uncertain. While our opinion is that interest rates will slowly move higher over time, there are no guarantees. Of course, one of the primary reasons to own fixed income investments is that this asset class is typically less volatile than stocks. Bonds, when used properly as part of a diversified investment strategy, may help smooth out a portfolio s overall performance. We made modest adjustments to all the models with a fixed income component during this rebalancing process. In four models (excluding Long Term Growth) we moved 2% from the short-term fixed income asset class into long-term fixed income. We are not expecting rates to rise quickly and we continue to see better opportunities for equity allocations over the next several years. Fixed income remains an important asset class in portfolios despite the low interest rate environment and our outlook for the future. Investors should be sure to diversify their fixed income holdings. With the movement in the fixed income market over the past year, we have moved to a neutral weighting in most areas across the fixed income spectrum. We do, however, recommend a slight underweight to U.S. Treasuries. We also continue to recommend a slightly short of benchmark duration in portfolios given our outlook for a modest increase in rates. Page 2 of 7

3 Equities All of the major indices experienced bouts of volatility in the second half of Last year the S&P 500, Dow Jones Industrial Average and NASDAQ Composite traded to all-time record highs around the middle of the year. In the second half of the year concerns over economic growth in China and credit market concerns due to weakness in the energy segment of the American economy all contributed to stock market anxiety. Despite these concerns, we believe the modest growth/modest inflation environment we have been living with for the last five years is not going to change any time soon. Although economic growth is below the longer term trend, investors around the globe have viewed the U.S. economy as dependable and our domestic stock market perceived as somewhat of a relative safe haven in an uncertain world. Inflation has also remained low in nearly all of the developed regions of the world. This year we look for the American economy to grow approximately 2.6%, a touch above last year s pace. Our analysis suggests 2016 S&P 500 operating earnings growth will be in the 6% to 7% range. Our year-end target range for the S&P 500 Index is We have a positive view of the stock market over the next 12 months and believe this cyclical bull market still has more room to run over the next couple of years. We look for the improving economy to push revenues ahead modestly in the coming year. Given our outlook for continued growth, we want to focus on those cyclical sectors which are more sensitive to the ebb and flow of the economy. As with fixed income, we only made modest adjustments to the equity allocations in this rebalancing process. We moved funds from the emerging markets equity asset class into the equity asset class. We continue to be cautious on emerging markets and have a positive outlook for domestic real estate in the coming 3-5 years. We feel it is appropriate to carry meaningful small and mid-cap allocations in the Moderate Growth and Long Term Growth models. However, we did slightly reduce exposure to small cap equity in both of those models and moved those allocations into other equity classes. Stocks overall, in our opinion, appear to be trading at more attractive valuations versus bonds. Thus, our weightings lean more toward equities in virtually all of the portfolios versus their respective benchmarks. One of the biggest risks to our outlook continues to be on the international front. While we continue to believe the rebalancing in emerging market economies away from exports and toward domestic consumption will be a major theme in coming years, below-trend growth in the developed countries is likely to continue to have a meaningful impact on emerging market economies. We do believe, however, that the efforts internationally by a number of major foreign central banks to stimulate their economies will have a positive effect on equity markets in coming years. Page 3 of 7

4 Style Our work suggests that allocations should be balanced in terms of value versus growth. At this point in the cycle a neutral approach is desirable in our opinion. As a result, we continue to carry a 50%/50% value versus growth weighting across large-, mid- and small-cap equity classes. The models We have five cyclical asset allocation models, which are described on the following pages. For investors with income as a primary objective, our allocations attempt to limit market risk and price volatility, as income investors tend to favor preservation of principal. However, maintaining purchasing power over a long period of time is also an important investment objective, and we also include what are perceived as more risk-oriented assets even in our income portfolios towards that goal. For those investors with growth objectives, our allocations are weighted more toward stocks, which usually have a fair amount of volatility and risk. Across all models, we stress diversification. We pay attention to our longer term strategic Capital Market Assumptions (CMAs) when allocating among the various asset classes. Our goal is to make cyclical adjustments around the long term CMAs based on where we are in the economic cycle. Our CMAs are return expectations based on longer-term trends we expect to prevail over the next 10 or 15 years (or approximately two market cycles). Currently, our allocations lean toward equities across virtually all of the portfolios and we continue to carry a more cyclical view in terms of sector exposure. In fixed income, note that we still remain slightly short duration versus the benchmark. We want to position the equity portion of the models to take advantage of our belief that the domestic and global economic recoveries will continue. Page 4 of 7

5 Moderate Income Moderate Growth High Yield Debt 6% Equity 2% Fixed Income 7% Equity 6% Equity 2% Equity 2% Equity 16% Fixed Income 6% Short-Term Fixed Income 17% Intermediate Fixed Income 34% High Yield Fixed Income 3% Equity 10% Equity 16% Equity 10% Equity 13% Equity 6% Intermediate-Term Fixed Income 3% Fixed Income 2% Equity 35% Conservative Growth & Income Growth High Yield Debt 5% Fixed Income 5% Equity 2% Equity 7% Equity 20% Short-Term Fixed Income 12% Intermediate Fixed Income 27% Fixed Income 8% Equity 12% Equity 21% Equity 12% Equity 33% Equity 16% Moderate Growth & Income Debt 5% High Yield Fixed Income 8% Equity 8% Equity 6% Equity 8% Short-Term Fixed Income 3% Intermediate Fixed Income 17% Fixed Income 7% Equity 28% Source: Wells Fargo Investment Institute. Page 5 of 7

6 Cyclical Asset Allocation models (First-quarter 2016) For more information on the Cyclical Asset Allocation Portfolio Plus (CAAP Plus) program, please ask your Financial Advisor. Moderate Income Conservative Growth & Income Moderate Growth & Income Moderate Growth Growth Current Change Current Change Current Change Current Change Current Change none 2% none 2% none 2% none 2% none Short-Term Fixed Income 17% (2%) 12% (2%) 3% (2%) (2%) Intermediate Fixed Income 34% none 27% none 17% none 3% none Fixed Income 6% 2% 8% 2% 7% 3% 2% 2% High Yield Fixed Income 7% none 5% none 8% none 3% none Equity 2% none 4% 2% 4% 2% 6% 4% 4% 2% Equity 16% none 20% none 28% none 35% none 33% 2% Equity 2% none 4% none 8% none 13% none 16% none Equity 2% none 4% none 6% none 10% (2%) 12% (2%) Equity 6% none 7% none 8% none 16% none 21% none Equity 2% (2%) 4% (3%) 10% (2%) 12% (2%) Debt 6% none 5% none 5% none Total 100% 100% 100% 100% 100% Source: Wells Fargo Investment Institute. Risk Considerations Asset allocation and diversification are investment methods used to help manage risk. They do not ensure a profit or protect against a loss. All investing involve risk, including the possible loss of principal. There can be no assurance any investment strategy will be successful or meet its investment objectives. Investors should be aware of, and understand, all risks associated with an advisory product s underlying holdings before investing. Some of the risks associated with the asset classes discussed in this report include: Equity Investments are subject to market risk which means their value may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. The prices of small and mid-company stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions. Growth stocks may be more volatile than other stocks. There are no guarantees that value stocks will increase in value or that their intrinsic values will eventually be recognized by the overall market. Both growth and value types of investing tend to shift in and out of favor. Equity s have special risks, including the possible illiquidity of the underlying property, credit risk, interest rate fluctuations, and the impact of varied economic conditions. Foreign/Emerging Markets investing involves greater risks than those associated with investing domestically including political, economic, currency and the risks associated with different accounting standards. These risks are heightened in emerging markets. Fixed Income securities are subject to interest rate and credit risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond s price. Credit risk is the risk that an issuer will default on payments of interest and principal. High yield fixed income securities are considered speculative, involve greater risk of default, and tend to be more volatile than investment grade fixed income securities. Treasury securities are considered free from credit risk but are subject to changes in interest rates. All fixed income investments may be worth less than their original cost upon redemption or maturity. General Disclosures The Cyclical Asset Allocation program is not designed for excessively traded or inactive accounts and may not be suitable for all investors. Please carefully review the Wells Fargo Advisors advisory disclosure document for a full description of our services. The minimum account size for these programs is $50,000. There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change. The information in this report was prepared by the GIS division of WFII. Opinions represent GIS opinion as of the date of this report and are for general informational purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including you existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon. Global Investment Strategy ( GIS ) is a division of Wells Fargo Investment Institute, Inc. ( WFII ). WFII is a registered investment adviser and wholly-owned subsidiary of Wells Fargo & Company and provides investment advice to Wells Fargo Bank, N.A., Wells Fargo Advisors and other Wells Fargo affiliates. Wells Fargo Bank, N.A. is a bank affiliate of Wells Fargo & Company. Page 6 of 7

7 The Global Investment Strategy Team Stuart Freeman, CFA Greg Sigmund, CFA Co-Head of Global Equity Strategy COO & Head of Global Research Paul Christopher, CFA Head Global Market Strategist Brian Rehling, CFA Co-Head of Global Fixed Income Strategy Sameer Samana, CFA Global Quantitative Strategist Scott Wren Senior Global Equity Strategist Cyclical Asset Allocation models Cyclical Asset Allocation models provide a rolling three-year outlook and are based not only on past performance of various asset classes but, more important, on future expectations. The Global Investment Strategy Committee focuses on yield for income accounts, return for growth accounts and risk exposure for all accounts by using quantitative research and qualitative experience. Because the committee continually looks forward, the recommended allocations may change in periods of less than three years, if market conditions warrant. The charts in this report illustrate the various allocations based on investor type. Changes to the models may be made quarterly. Additional information is available upon request. The material contained herein has been prepared from sources and data we believe to be reliable, but we make no guarantee as to its accuracy or completeness. This material is published solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or investment product. This material is not to be construed as providing investment services in any jurisdiction where such offers or solicitation would be illegal. Opinions and estimates are as of a certain date and subject to change without notice. You should be aware that investments can fluctuate in price, value and/or income, and you may get back less than you invested. Past performance is no guarantee of future results. Investment or investment services mentioned may not be suitable for you, and if you have any doubts, you should seek advice from your Financial Advisor. Where an investment is described as being likely to yield income or as being suitable for an investor particularly seeking income, the income from the investment may fluctuate and part of the capital invested may be used to pay that income. Where the purchase or sale of an investment requires a change from one currency to another, fluctuations in the exchange rate may have an adverse effect on the value, price or income of the investment. Wells Fargo Advisors is registered with the U.S. Securities Exchange Commission and the Financial Industry Regulatory Authority, but is not licensed or registered with any financial services regulatory authority outside of the U.S. Non-U.S. residents who maintain U.S.-based financial services account(s) with Wells Fargo Advisors may not be afforded certain protections conferred by legislation and regulations in their country of residence in respect of any investments, investment transactions or communications made with Wells Fargo Advisors. Investment and Insurance Products: NOT FDIC Insured NO Bank Guarantee MAY Lose Value Brokerage products and services are offered through Wells Fargo Advisors. Wells Fargo Advisors is the trade name used by two separate registered broker-dealers: Wells Fargo Advisors, LLC and Wells Fargo Advisors Financial Network, LLC, Members SIPC, non-bank affiliates of Wells Fargo & Company. First Clearing, LLC, Member SIPC, is a registered broker-dealer and non-bank affiliate of Wells Fargo & Company Wells Fargo Investment Institute. All rights reserved Page 7 of 7