Global Asset Allocation Perspective

Nobody Told Me There’d Be Days Like These

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Third Quarter 2014

Rich Weiss
Senior Vice President and Senior Portfolio Manager
Asset Allocation Strategies

Crises in the Ukraine and Middle East remind us that catastrophes (whether natural or man-made) do occur from time to time. While recognizing their profound human import, such events typically have only short-lived effects on financial markets. Ultimately, we believe diversification is one of an investor’s only protections from geopolitical and financial shocks.

Allocation Highlights

  • We believe the best way to deal with financial and geopolitical uncertainty is through broad diversification among and within asset classes, as well as geographic regions. Well-diversified investors, who are taking an appropriate level of risk in their portfolios, should be properly positioned to ride through the market ups and downs.
  • Our models continue to favor stocks relative to bonds and cash, while within equities our readings show a preference for growth- over value-oriented shares. Add it all up, and we are maintaining our long-running, modest overweight to stocks.
  • Our fixed-income team’s macroeconomic view suggests that we are likely to enjoy modest global growth, though they see increasing pressure on inflation and interest rates going forward, particularly in the United States.
  • Within our fixed-income allocation, we continue to limit interest rate risk and prefer corporate- and mortgage-backed securities over government bonds.

Most Peculiar, Mama

Pundits and investors everywhere have noted the peculiar market conditions at present—stocks and bonds rallying together; stock market volatility at a post-financial crisis low; conflicts raging in eastern Europe and the Middle East; daily headlines proclaiming the return of inflation followed by Federal Reserve (Fed) governors talking down the likelihood of inflation; and so on. At such times we’re reminded of the John Lennon classic, "Nobody Told Me," which includes the lines "there’s always something happening but nothing’s going on … strange days indeed."

So what’s an investor to do? We have written extensively in these pages and in past editions of CIO Insights about the need for a consistent investing plan to deal with changing market conditions, particularly Scott Wittman’s You Can’t Model the Newsflow, from the second quarter of 2011. That write-up was precipitated by—you guessed it—violence and political change sweeping the Middle East, while Europe was at the height of financial and political crises. Seen in this light, economic and geopolitical turmoil seem less the exception to the rule and more the norm. As a result, we should reiterate something we emphasize often: Reacting to events in a knee-jerk fashion is rarely a winning strategy.

Equities in the Right

Geopolitical risk and still-stimulative Fed policies are combining to keep interest rates in the United States artificially low. Investors nervous about geopolitical events, bankruptcy in Argentina, and emerging-market growth, among other factors, still view Treasury bonds as a potential safe haven in times of turmoil. At the same time, low bond yields increase the relative appeal of stocks. What’s more, Fed governors are working hard to talk down the threat of inflation and to encourage risk taking, believing that the wealth effect from higher stocks is another way to support the economy. This helps explain why stocks and bonds have been rallying together, contrary to all expectations.

Ultimately, we think equity investors have it right—we see the recent rally in bonds as being driven by transitory factors. In addition, we’re beginning to see early warning signs of inflation. Finally, the Fed is slowly but surely cutting back on stimulus. Therefore, we think it is highly likely that rates will rise going forward. If rates rise because the economy is improving, then that would likely be positive (or at least not as detrimental) for equities.

Outside the U.S., emerging markets are more problematic, given prevailing debt, currency, and political challenges. Having said that, select companies and markets are well positioned to benefit from the global recovery, arguing for a selective, active approach to emerging market investing.

Fixed-Income Positioned for Better Growth

Our fixed-income positioning reflects our expectation for better growth in the U.S., which suggests upward pressure on interest rates and inflation. Given those conditions, we’re underweight Treasury and government agency bonds, and seek to avoid longer-term, more rates-sensitive securities. Instead, we believe opportunities exist in non-dollar bonds, high-yield corporates, short-term inflation-indexed securities, and municipal bonds.

International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
Understanding inherent risks such as interest rate fluctuation, credit risk and economic conditions are important when considering an investment in real estate.

Diversification does not assure a profit nor does it protect against loss of principal.

The opinions expressed are those of American Century Investments (or the fund manager) and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.

For detailed descriptions of indices or investing terms referenced above, refer to our glossary.

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