Monthly Market Comentary

Source: Morningstar Direct daily total return data for SPY, EFA, EEM, AGG, TIP, DBC, GLD, & ICF

Following a few years of tough performance for emerging market equities, investors have shifted their attention to emerging markets in 2017, driving up prices in EM close to 30% since the beginning of this year.  Generally speaking, all global equities have experienced solid positive returns this year, despite the already expensive valuations.  On another note, broad commodities have been bouncing around quite a bit, with a weak start to the year that has completely recovered in the past three months.  Gold has also been quite volatile with a shift to long-term positive momentum this year, which started in late 2016.

Source: Morningstar Direct daily total return data for SPY, EFA, EEM, AGG, TIP, DBC, GLD, & ICF

Although momentum has been quite strong for equities, broadly speaking, it’s unclear when the technical signals will shift to be more in line with the fundamentals.  Both large- and small-cap US equities have been richly valued over the past few years, but they continue to become more expensive.  Based on the forward looking real return expectations of GMO and Research Affiliates, which take into account elements of reverting to mean valuations and both yield and growth for each of the asset classes over the coming full market cycle (7-10 years), there are two key observations to be made:

1. In absolute terms, future expected returns are much lower than what we have historically experienced, especially compared to the rosy returns of the recent past ten years.
2. In relative terms, international markets (especially EM) offer much better investment opportunities than domestic equities.

Source: GMO 7-Year Asset Class Real Return Forecasts as of 8/31/2017, Research Affiliates Asset Allocation Interactive Data as of 8/31/2017

It’s useful to consider how future returns are expected to be muted compared to the long-term returns experienced in each of these asset classes; however, that is mostly useful from a planning perspective to make sure your individual goals can still be accomplished given a lower-return environment.  The relative return expectations are much more useful when considering your optimal asset mix within your investment portfolio.  For instance, noticing that US equities are significantly overvalued and pose a serious potential risk within your portfolio – expected to barely beat inflation at best, or possibly some significant drawdowns in the near-term at worst – it would probably be prudent to shift a portion of your allocation that would normally be in US equities into other asset classes that may have less risk of poor performance in the coming years.  Just remember that following a repeatable process for making allocation decisions is key here, so that you can use the relevant data in meaningful ways to reduce risk in your portfolio over the long-term.