Investment Strategy

How did my asset allocation perform in 2018?

Last year was a difficult one for investors. Every major asset class lost money, meaning there were few places to hide. This is relatively unusual.

Glancing down the list of regional and country stock indices provided by MSCI, it’s clear that stocks got hammered in 2018. Below is a summary of year-to-date performance, until 24th December, of the main regional markets (they bounced a little in the last few days of the year).

All are measured in US dollars and including dividend income. (I’ve included the USA along with the other groupings, since it’s roughly half of global market capitalization).

  • USA -11%
  • Europe -15%
  • Emerging Markets -16%
  • Frontier Markets -17%
  • All-Country World Index, ACWI (23 developed and 28 emerging) -13%

How about the best and worst performers in the different development categories?

Best performers:

  • Developed markets: Finland -3%
  • Emerging markets: Qatar +31%
  • Frontier markets: Zimbabwe +119%

Worst performers:

  • Developed markets: Austria -28%
  • Emerging markets: Greece -36%
  • Frontier markets: Argentina -55%

Clearly, Qatar and Zimbabwe were the places to be. But neither is easily investable, for practical purposes. In terms of accessible stock markets, Russia was the best emerging market performer, gaining 0.4%.

The big falls in stock markets illustrate why it’s always important to stay diversified. Regular readers will know that I’ve recommended a conservative portfolio allocation since August 2017.

It’s spread across stocks, cash (or equivalents, such as treasury bills), gold and long-dated US treasury bonds. The following table summarizes the recommended allocations.

Below is a chart that summarizes how the main asset classes performed up to 24th December. I’ve included the following ETFs:

  • For US stocks: Vanguard S&P 500 ETF (NYSE:VOO)
  • For global stocks: iShares MSCI ACWI ETF (NASDAQ:ACWI)
  • For emerging market stocks: iShares MSCI Emerging Markets ETF (NYSE:EEM)
  • For long-dated US treasury bonds: iShares 20+ Year Treasury Bond ETF (NASDAQ:TLT)
  • For gold: SPDR Gold Shares (NYSE:GLD)

Source: Yahoo Finance

As you can see, US stocks did quite well until September, although it was a bumpy ride. But they collapsed in the fourth quarter, and the collapse accelerated significantly in December.

Unusually, US treasury bonds also fell when stocks were falling sharply in both February and October. It was only during November and December that bonds gained as stocks fell, reclaiming their role as a hedge against stock market falls. Gold also fell until the end of September, but has since risen. At last, the bond and gold pieces are providing diversification from stocks once again.

The following chart looks just at US stocks (VOO), long-dated treasuries (TLT) and gold (GLD) over the past 6 months. This shows more clearly how treasuries and gold rose in the fourth quarter as stocks plummeted.

Diversification was back in the fourth quarter

Source: Yahoo Finance

As with any year, 2018 had its big, macro themes. Below are the main ones:

  1. Lower US corporate taxes, which boosted earnings.
  2. More confrontational US trade policy, including higher import tariffs, which hit earnings of some companies (or could in future). Some countries, such as China, retaliated on imports of US goods.
  3. The end of years of quantitative easing (QE) by central banks, the process of creating new money to funnel into financial markets. In the case of the US Federal Reserve, the start of quantitative tightening (QT), the process of draining money from financial markets.
  4. In the US, raising interest rates to get them back to something closer to normal. This put pressure on bond prices, as yields rose.

That last point was particularly important, since it was a big factor in dollar strength relative to other currencies. This weighed on investment performance, when measured in dollars. Foreign earnings of US corporations, which are substantial, became worth less in dollar terms, which suppressed profit growth. Foreign stock prices, measured in other currencies, became worth less once translated into their dollar equivalent.

Below is a chart of the broad trade-weighted dollar index over the past 12 months. This tracks the dollar against 26 foreign currencies. Since one of those currencies is the euro, and the euro area includes 19 countries, it tracks the US dollar against the currencies of 44 countries overall, being the US’s main trade partners.

US dollar strength – year to 12th December 2018

Source: Federal Reserve Bank of St. Louis

For the most part, commodities didn’t provide refuge for investors either. The Thomson Reuters / Core Commodity CRB index was down 10%. WTI crude oil was down 26% and Brent crude was down 21%. Copper was down 19% and silver was down 13%. The few bright spots were found in things like natural gas (up 22%) and speculative agricultural commodities such as corn (maize), wheat and cocoa (although soybeans were down).

With practically everything down, 2018 turned out to be the year of the US dollar. Just sitting on dollar cash, or an equivalent like US treasury bills, ensured no loss in dollar terms (and a gain when measured in most other currencies).

But that’s easy to say with hindsight. Things could have turned out very differently, especially if the US administration hadn’t unsettled markets with its trade pronouncements and policies.

In any case, I’ve had a look at how my own recommended asset allocation performed during 2018. As you’ll have seen above, it had a big allocation to cash (35%). Using the SPDR Bloomberg Barclays 1-3 Month T-Bill ETF (NYSE:BIL) as a proxy for that cash holding, in US dollars, I’ve worked out how the recommended portfolio performed.

First I’ve done it with the S&P 500 index filling the stock allocation. This gives a modest portfolio loss of 1.6% during 2018 (figures up to 31st December), including income and net of ETF fees. Below is a summary of the calculation.

Substituting the S&P 500 (net loss 4.4%) for the ACWI index (net loss 9.0%) gives a portfolio loss of 3.4%.

Clearly, a loss is never a good thing, even when it’s unrealized (meaning just down to market price moves of positions, and not crystalized by selling investments). But the recommended asset allocation has done its job of providing diversification and limiting the downside. This has been achieved in a year where stock market sentiment shifted from extremely bullish in January to heavily bearish in December.

In particular, the large cash allocation is doing its twin jobs. During the stock market downturn it provides “ballast”, keeping the overall portfolio ship steady, and limiting downside. Once the current turmoil has passed, it’s there to be used as “ammo”, scooping up bargains that will provide substantial profits once stock markets recover.

As we’ve moved into January 2019, things appear to have stabilised. Will it last? Only time will tell.

I keep my recommended asset allocations under constant review. But I’m not going to change them just yet. With ongoing trade negotiations between the World’s two largest economies – the US and China, Brexit looming in March and rising rates, patience remains the name of the game.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.