Knowledge Center

The Wilshire Advisor Solutions Knowledge Center contains our video presentations, white papers, monthly and quarterly market commentaries, and product literature.

MORE IN THIS CATEGORY: Market Commentary, Commentary
25 Latest Articles

  Investment Strategy Update, May 2017

Investment Strategy—Positioning for Relative Opportunities

Global equity markets continued to climb higher early in the first quarter of 2017, on momentum and positive sentiment in response to the surprise election of Donald Trump. The market had been pricing in optimism regarding the new administration’s ability to execute on its policy agenda of lighter regulation and looser fiscal policy. However, markets were met with resistance mid-quarter on the heels of a failed health care vote and the realization that future policy actions may be less certain. We expressed our concern in our last letter that there remains significant uncertainty regarding actual policy implementation, noting that our analysis continues to focus on the fundamentals of the macroeconomic landscape, while considering how such fundamentals may change in response to policy actions.

Our analysis continues to indicate moderating economic growth and inflation, which informs our view that rates are likely to be low for longer, even in the face of gradual tightening of monetary policy by the Federal Reserve. We continue to believe that the current economic landscape warrants lower interest rates and lower expected returns across asset classes. In order to adapt to evolving conditions, the Wilshire Funds Management Investment Strategy Committee meets at least quarterly to reassess a variety of factors, including but not limited to economic, fundamental, technical, and risk indicators. Our most recent assessment of global market conditions has resulted in modest changes in our portfolios, as we remain consistent in our slightly cautious risk posture relative to our strategic asset allocation policy(s), most specifically through an underweight in equity risk in favor of credit risk and alternative investments. Although our views are directly reflected in our portfolios, we have also included a broad review of the changes in our views since January, with a summary of our rationale and supporting exhibits in the proceeding sections. We will continue to keep you apprised of our market perspectives and positioning.

 

Asset Class January Change April
Fixed Income vs. Equity Overweight Overweight
Alternatives vs. Equity Overweight Overweight
Alternatives vs. Fixed Income Neutral Neutral
Duration vs. Bloomberg Barclays Capital Aggregate Bond Index Neutral Underweight
Credit vs. Government Overweight Overweight
Investment Grade vs. High Yield Neutral Neutral
High Yield vs. Bank Loans Underweight Underweight
Non-U.S. vs. U.S. Fixed Income Large Underweight Underweight
Large Cap vs. Small Cap Equities Overweight Overweight
Growth vs. Value Equities Underweight Neutral
Global ex-U.S. vs. U.S. Equities Neutral Overweight
Emerging Markets vs. Developed Equities Overweight Overweight
Global REITS vs. Global Equities Neutral Neutral
Commodities vs. Global Equities Neutral Neutral

 

Asset Class Change View Summary of Rationale
Fixed Income vs. Equity Overweight
  • Equities continue to exhibit higher than normal valuations and below average earnings growth.
  • Economic data is still broadly inconsistent with a significant rise in interest rates, and we expect any move by the Fed to materially raise rates in this environment will be met with a more negative response in risk assets.
  • Our overweight to fixed income continues to be implemented through an overweight to high yield as a substitute for equity risk, with the objective of reducing equity beta while earning additional yield in an environment of lower expected returns.
Alternatives vs. Equity Overweight
  • We maintain our overweight in alternatives, which is specifically implemented through equity hedge strategies.
  • This continues to serve the objective of reducing equity beta and introducing more alpha- oriented strategies that can benefit from the additional breadth of short positions.
Altnernatives vs. Fixed Income Neutral
  • We continue to believe that interest rates will be low for longer, given modest levels of inflation and economic growth on a global basis, and we believe that fixed income will continue to serve as one of the best sources of diversification to equity risk.
Duration vs. Bloomberg Barclays Capital Aggregate Bond Index Underweight
  • Our decision to reduce duration is more in response to rising duration exposure in the benchmark, and we have decided to be only slightly shorter than the benchmark, as we still find duration exposure to be complementary to our equity risk exposure.
Credit vs. Government Overweight
  • We are mindful of valuations in credit, however we believe that the incremental yield in investment grade bonds provides valuable income in a low return environment.
Investment Grade vs. High Yield Neutral
  • Cross-sectional valuations do not warrant a deviation from neutral posture.
High Yield vs. Bank Loans Underweight
  • Bank loans offer similar yield spreads relative to high yield, with significantly less volatility.
Large Cap vs. Small Cap Equities Overweight
  • Consistent with our relative underweight to equities, large caps exhibit lower equity beta.
Growth vs. Value Equities Neutral
  • The current valuation dispersion between growth and value is not materially different relative to the long-term history of this measure, and the performance of value vs. growth is largely dependent on the outcome of government policy, which is too uncertain for our risk budget.
Global ex-U.S. vs. U.S. Equities Overweight
  • Foreign equities are more attractive on a valuation basis, and the USD is overvalued relative to the euro, yen, and pound, which may create an additional tailwind for foreign returns in USD.
Emerging Markets vs. Developed Equities Overweight
  • Valuations remain considerably more compelling on a relative basis.
Global REITS vs. Global Equities Neutral
  • Cross-sectional valuations do not warrant a deviation from neutral posture.
Commodities vs. Global Equities Neutral
  • Although inflationary pressures are limited, we are witnessing technical stability in energy prices (with a trading range), and believe that underweight exposure is no longer prudent.

 

Macroeconomic Outlook

  • Our assessment of the macroeconomic landscape indicates moderating economic growth and inflation on a global basis, as shown in Exhibits A and B.
  • Developed markets remain relatively stable in terms of GDP growth on a normalized basis, and we are still seeing below average growth in emerging markets, albeit faster than in developed markets.
  • On a forward looking basis, we continue to be mindful of the economic uncertainty resulting from “Brexit,” but we also observe improving growth data in the face of this uncertainty.
  • On a global basis, measures of inflation are mostly in-line with or slightly below historic averages.
  • Given that central banks are no longer pressing forward with aggressive accommodation in monetary policy, the global economy will be more reliant on other forms of government policy going forward, including but not limited to fiscal stimulus.

Exhibit A: Country GDP Growth (Normalized, 15 years)

Exhibit A: Country GDP Growth (Normalized, 15 years)

Source: Bloomberg

Exhibit B: Country CPI Growth (Normalized, 15 Yrs)

Exhibit B: Country CPI Growth (Normalized, 15 years)

Source: Bloomberg

Exhibit C: Conference Board U.S. Leading Economic Index MoM

Exhibit C: Conference Board U.S. Leading Economic Index MoM

Source: Bloomberg

  • U.S. economic growth continues to disappoint on a year-on-year basis (2.0% in 2016), as we see signs of moderating growth in the U.S.
  • Exhibit C shows the Conference Board U.S. Leading Economic Index, which shows a recent uptrend in leading economic indicators on the heels of improvements in consumer expectations, new orders, building permits, and wider interest rate spreads (10-Year Treasury — Fed Funds).

Exhibit D: U.S. Consumer Price Index

Exhibit D: U.S. Consumer Price Index

Source: Bloomberg

Exhibit E: Inflation Measures

Exhibit E: Inflation Measures

Source: Bloomberg

  • As shown in Exhibit D, the recent rise in headline inflation over the past six months was primarily due to the rise in energy prices off of a very low base.
  • The most recent month-on-month reading for CPI was -0.3% in March, as energy prices began to reverse course. It’s important to note, however, that non-energy related commodity prices also began to soften which weighed on core inflation (-0.1% for March). Food prices represented the only positive contribution to inflation in March. Yearon- year headline and core inflation now sit at 2.4% and 2.0%, respectively.
  • U.S. Personal Consumption Expenditures has been on an uptrend and now sits just above the Fed’s 2% target. This represents one of the Fed’s most favored measures of inflation, and based on this indicator, we would expect the Fed to continue to be gradual with its tightening policy so as not to stymie healthy inflationary pressure.
  • We maintain our view that given the very low bond yields that we continue to witness in developed Europe and Japan (supporting continued global demand for dollars), it is challenging to envision a material rise in interest rates in the U.S.
  • We continue to expect a moderating economic growth environment in the foreseeable future, and therefore, we believe that the current economic landscape warrants lower interest rates and lower expected returns across asset classes. As a result, we have maintained our more cautious positioning, most specifically in our equity allocations, where we remain underweight.

Fixed Income Outlook

  • We remain overweight in fixed income relative to equities, specifically by replacing equity risk with credit risk.
  • Given ultra-low foreign developed market bond yields, we favor domestic fixed income over global fixed income, however we have reduced our overweight to U.S. bonds, primarily in recognition that the euro, yen, and pound are notably undervalued relative to the dollar, and any weakness in the dollar would serve to benefit foreign fixed income.
  • From an interest rate risk perspective, we now seek to be slightly shorter in our duration exposure relative to each client’s benchmark exposure. We have continued to reiterate our belief that rates will remain low and interest rate sensitivity may still provide a diversification benefit, although more limited, in the event that the economy and inflation continue to grow at a moderate pace.
  • We continue to believe that the economic data is broadly inconsistent with restrictive monetary policy, and while it is probable that the Fed will raise interest rates further in 2017, we expect any move to significantly raise rates in this environment will likely be met with a more negative response in risk assets (such as equities). Exhibit F below shows that the market is pricing in a high probability (approximately 80%) of one additional rate hike by December, and a modest probability of two rate hikes (approximately 40%).
  • With respect to credit markets, we are mindful of higher valuations, however we believe that the incremental yield in investment grade bonds provides valuable income in a low return environment.
  • That being said, we believe that allocating to credit as a replacement to equities is prudent, primarily with the goal of reducing equity risk while “getting paid to wait” in what we expect to be a lower return environment.

Exhibit F: Futures Implied % Probability for One Rate Hike (Orange) and Two Rate Hikes (Blue) by December (Current Fed Funds is 0.75–1.0%)

Exhibit F: Futures Implied % Probability for One Rate Hike (Orange) and Two Rate Hikes by December

Source: Bloomberg

Equity Outlook

  • Our equity heat map expresses positive and negative signals through green and red indicators, respectively.
  • On a cross-sectional basis (Exhibit G), we observe that U.S. equities are now more than one standard deviation more expensive relative to their non-U.S. developed market counterparts. Furthermore, we find the USD to be overvalued against major developed market currencies, which may lead to performance tailwinds for foreign equity allocations if we see weakness in the U.S. dollar. As a result, we believe that moving to an overweight posture to foreign equities versus U.S. equities will provide the best opportunity to outperform on a relative basis.
  • Higher equity valuations in conjunction with higher Treasury yields over the past six months has led to a considerable decline in the equity risk premium, as shown in Exhibit H. This implies that investors are being compensated meaningfully less for taking equity risk relative to government bonds.
  • We have moved past an earnings recession, and earnings forecasts for 2017 are very optimistic—now approximately 9.8% earnings growth for the S&P 500 Index, down from earlier estimates of 13%. As we’ve discussed in the past, these expectations are largely driven by margin expansion, and a recovery in earnings for the Energy sector which imply an average oil price of approximately $54. We continue to see considerable risk to this optimism and forecast.
  • While we are encouraged by the market’s ability to shrug of geopolitical concerns and moderating economic growth, we believe that ultra-low levels of implied volatility, as measured by the VIX Index, remain symptomatic of complacency, particularly in the face of high valuations.
  • We believe that maintaining a slight underweight to equity risk while still seeking to harvest returns through our allocation to credit risk is prudent. We will continue to adapt our portfolios to market conditions and promote diversification to dampen the volatility of our client portfolios with the objective of achieving long-term financial objectives.

Exhibit G: Cross-Sectional Equity Valuations (forward P/E, 15 years, normalized)

Exhibit G: Cross-Sectional Equity Valuations (forward P/E, 15 years, normalized)

Source: Bloomberg

Exhibit H: U.S. Equity Risk Premium (S&P 500 Earnings Yield — 10 year Treasury Yield)

Exhibit H: U.S. Equity Risk Premium (S&P 500 Earnings Yield – 10 year Treasury Yield)

Source: Factset

Important Information
Wilshire Funds Management (“WFM”) is a business unit of Wilshire Associates Incorporated (“Wilshire®”).

Wilshire is a registered service mark of Wilshire Associates Incorporated, Santa Monica, California. All other trade names, trademarks, and/or service marks are the property of their respective holders.

This material contains confidential and proprietary information of Wilshire. It may not be disclosed, reproduced or redistributed, in whole or in part, to any other person or entity without prior written permission from Wilshire Funds Management.

This material is intended for informational purposes only and should not be construed as legal, accounting, tax, investment, or other professional advice. Past performance does not guarantee future returns. This material may include estimates, projections and other “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those presented.

This material represents the current opinion of Wilshire based on sources believed to be reliable. Wilshire assumes no duty to update any such opinions. Wilshire gives no representations or warranties as to the accuracy of such information, and accepts no responsibility or liability (including for indirect, consequential or incidental damages) for any error, omission or inaccuracy in such information and for results obtained from its use. Information and opinions are as of the date indicated, and are subject to change without notice.

© 2017 Wilshire Associates Incorporated. All rights reserved.

170477 E0717

MORE IN THIS CATEGORY: Market Commentary, Commentary

Name:
Email:
Subject:
Message:
x
Recent Articles
divider
Recent Articles
divider
Recent Articles
divider

Replay Coming Soon

2017 Third Quarter Market Update
  • Presented by: Josh Emanuel, CIO, Wilshire Funds Management
  • Date: Wed., Oct. 18, 2017