Long Term View and Analysis of Risk: How it Affects Your 2012 Asset Allocation

2012 Long Term View

The beginning of the year is a good time for asset allocation and risk management analysis for 2012. A view of the current long term investment environment is the first step.

Long Term View

The last 12 years have seen two bubbles; the dot.com bubble, and the housing bubble. Both market price bubbles produced extreme market volatility. I believe we are in a 15-20 year bear market that began in 2000, and still have one more bubble left to deflate; that being local, state, and federal governments. That probably means no bull market for several more years. It also means more challenging times ahead for investors with continued volatility and the need for a flexible asset allocation strategy that adapts to current market realities and valuations.

The next steps are risk management analysis and then an asset allocation management solution that allows the flexibility required to successfully build wealth in volatile and uncertain markets.

Risk Management Analysis

On the positive side, corporate America is financially sound and stock prices are not at the extreme overvaluation of a few years ago. Home values have fallen closer to equilibrium price where buyers and sellers will be equalized. Once that price is reached the housing market should improve. Unfortunately, that equilibrium probably won’t be reached in 2012. This is a requirement for job growth and a robust economy.

Global financial markets face hard challenges and many risks in 2012. Several European nations, namely Portugal, Ireland, Iceland, Greece, and Spain (PIIGS) have the potential to throw Europe into deep recession or even a deflationary depression. The European Union has only a few choices; all the options are hard and painful. The high probability of sovereign defaults that could spread through the global banking system means risk must to be assessed on an ongoing basis.

In the United States, all three levels; local, state, and federal governments, have increased their expenditures and unfunded liabilities to unsustainable levels. The governments, at each level, have exploding deficits, soaring debt, and mounting unfunded liabilities. All levels of government have to look at painful solutions to overcome short term and structural deficits. Cutting government services, employee layoffs, tax increases, restructuring of pension promises, defaults, and bankruptcies are all possibilities across the country. Any way you look at it, all the options will involve pain, economic dislocations, and most likely more stock market volatility for several years to come.

Asset Allocation in 2012

The lesson we should have learned from the past 12 years and our risk management analysis is that volatility will likely continue. Buy and hold strategies may work well when the stock market is rising in a cyclical bull market. But volatile flat and down markets require investors to use a tactical asset allocation to minimize investment loss. A tactical asset allocation provides the flexibility to rebalance the percentage invested in asset categories, depending on their valuation. The goal is to improve the risk adjusted rate of return of a portfolio as compared to a passive management strategy. The objective is to overweight asset classes that are undervalued and underweight asset classes that are overvalued.

Interest rates being at historic lows give a boost to the argument of owning dividend paying stocks with quality balance sheets. The AAAMP starts the year with an over weighted position in blue-chip dividend paying stocks and cash.

Cash is king now because we don’t have a clear inflation trend at the current time. It is the trend of inflation, not the absolute level of inflation, which has the largest effect on the direction of the market. As long as deflation and inflation are both distinct possibilities investors should overweight cash. Investors who are able to decipher the inflation trend ahead of the masses will be able outperform the market. Right now you must be prepared for both! There are too many variables in Federal Reserve and Government Fiscal policies for anyone to make more than a guess at this time.

The current investment environment makes asset allocation and risk management in 2012 critical to preservation of capital and long term performance.

Related Reading:   Risk Management

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