Economics

What Jerome Powell Could Mean For Your Portfolio

How alts can help you keep calm and carry on

A cool customer. Mr. Ordinary. Consensus builder.

As Jerome Powell testified before the Senate Banking Committee in November, analysts tended to paint him as a reliable quantity. If confirmed as the new Fed chair, Powell largely is expected to continue Janet Yellen’s monetary policy, including gradually raising interest rates in parallel with economic growth.

[REITs]

Jerome H. Powell Jerome Powell

The hearing’s biggest flashpoint was around financial regulation. Powell told Democrats that he felt there was no need for stronger banking regulations after eight years of writing new rules.

Then he balanced those comments by telling Republicans that most current regulations should remain in place. One exception was his desire to take a “fresh look” at the regulatory burden on smaller banks.

Highest valuations since 1900

A new Fed chair is just one of many factors that investors will need to take into account as they rebalance their portfolios ahead of 2018.

Analysts at Goldman Sachs recently pointed out that market valuations for stocks and bonds are at their highest level since 1900. They painted two scenarios for traditional 60/40 investors: lower returns across all assets over the medium term, and a period of “fast pain” with a negative growth shock and the possibility of rising inflation.

Neither of these scenarios sounds especially appealing. That may be why Goldman recommended in July that investors take their own “fresh look” at alternatives.

Rebalancing for a smoother ride

It’s true that investors with thoughtful allocations to alternatives may be better insulated from such drawdowns. That begins with understanding how to define a quality alternative. At Longboard, we believe true diversifiers historically:

  1. Lower risk (through lower correlation in declining markets)
  2. Increase returns

There are only a handful of assets that meet this sniff test. To help you evaluate which belongs in your portfolio, we’ve examined the environments in which each asset historically has performed best. You can read our full analysis, or just check out the four true diversifiers that can benefit from inflation.

Gold

  • Outperforms during inflationary periods such as the 1970s and 2000s.
  • Underperforms during periods of price stability and high interest rates such as the 20-year period from 1982 – 2002. Gold also underperforms during deflationary periods, like the commodities deflation from 2011-2015.

Managed Futures

  • Outperforms during periods of sustained price trends across multiple asset classes, including both inflationary and deflationary environments.
  • Underperforms during periods of price stability across multiple asset classes, like the noninflationary growth environment of 2011-2013, or during transition periods from deflation to inflation and vice versa.

MLPs

  • Outperforms during inflationary periods with rising oil and gas prices.
  • Underperforms during deflationary periods with falling oil and gas prices.

TIPs

  • Outperforms during inflationary periods with rising consumer prices (measured by the CPI), like the mid-2000s and the initial recovery from the Financial Crisis in 2009-2011.
  • Underperforms during deflationary periods with declining consumer prices (measured by the CPI), like the 2008 Financial Crisis and the deflationary period from 2014-early 2016.

We believe investors who make a meaningful allocation to true diversifiers may be able to emulate Powell’s recent performance. They can stay calm and collected – no matter what comes next from the Fed or the markets.

Sources:

https://www.newyorker.com/news/our-columnists/nine-things-we-learned-on-tuesday-about-the-next-fed-chairman

https://www.wsj.com/articles/mr-under-the-radar-jerome-powell-trumps-federal-reserve-pick-signals-continuity-1509643306

https://www.nytimes.com/2017/11/28/us/politics/jerome-powell-federal-reserve-nominee-testimony.html

https://www.cnbc.com/2017/11/28/fed-nominee-powell-backs-tailoring-regulations-to-ease-up-on-small-banks.html

https://www.bloomberg.com/news/articles/2017-11-29/goldman-warns-highest-valuations-since-1900-mean-pain-is-coming

https://longboardfunds.com/articles/evaluating-true-diversifiers

Article by Longboard Funds