Two Current Investment Themes and Four-Wheel Drive Portfolios

View the Two Current Investment Themes and Four-Wheel Drive Portfolios pdf here.


By: DeFred G Folts III, Chief Investment Strategist


After a decade of U.S. equity markets climbing inexorably to new all-time highs, the way forward may now become more difficult for advisors and their clients as they face the potential for significant uncertainty, volatility, and increased market risk. Markets seem vulnerable to a wide variety of potential risks, including ongoing trade tensions between the U.S. and China, which could negatively impact global economic growth. In addition, markets often seem to be whipsawed by the President’s Tweets about U.S. / China trade, or the Federal Reserve. Investors are also laser-focused on the Fed and other of the world's major central banks in the hope that central bank liquidity could continue to propel asset prices even higher. In this environment, the question that I often hear is, after a 10-year bull market in U.S. equities, is it now time to get out of equities? At 3EDGE Asset Management, our response is that this decision shouldn't be binary; it isn't necessarily a question of all-in or out.

3EDGE Asset Management is a global, multi-asset investment management firm, and therefore, we invest across asset classes and geographies by way of Exchange Traded Funds (ETFs). Our globally diversified strategies will always hold some amount of equities, bonds, commodities – including gold – as well as cash. Each strategy has specific asset class ranges governed by minimum and maximum percentage holdings based upon the return targets and risk parameters for each strategy. Therefore, no matter how positive our research may be towards any of the major asset classes that make up our investment universe, each of our investment strategies will usually hold an amount up to a pre-determined maximum range. Conversely, each of our investment strategies will usually hold a minimum amount of the major asset classes mentioned above. Within these pre-determined asset class ranges, we dynamically adjust our portfolio holdings based upon projections from our model research, which we describe as combining scientific methodology, sound judgment and experience.

Global Capital Markets Outlook.

The 3EDGE model is the result of over four decades of study of global market behavior, and it serves as our navigation system informing our dynamic portfolio allocation decisions. Let’s look at two of the many current investment themes emanating from our proprietary research model of the global capital markets.

U.S. Equities appear significantly overvalued.

Based upon our approach to calculating equity market valuations* (see chart and our valuation methodology on the following page), our model indicates that the S&P 500 equity index remains almost as overvalued as it was just prior to the bursting of the tech stock bubble in 2000, and in the neighborhood of being as overvalued as it was just prior to the crash of 1929. Of course, we also know full well that markets are quite capable of becoming even more overvalued before eventually correcting back to more normal levels of valuation.

*3EDGE Equity Valuation Methodology. We believe that traditional P/E ratio analysis may not be sufficient in providing adequate insight into equity valuations. Therefore, we have developed our own methodology for understanding equity market overvaluation by comparing 3EDGE's model of current P/E ratios adjusted for normalized profit margins to fair value P/E calculations that incorporate both existing and long-run cost of capital in addition to implied growth rates.

Gold remains an attractive asset class.

Gold recently reached a six-year high and with real interest rates (nominal rates less inflation) in decline and with the potential for the Fed and other of the world’s central banks to continue to pursue easier monetary policies in what amounts to a global competitive currency devaluation - - gold could continue to benefit. One way to think about gold as an asset class is not as a shiny yellow metal but as the ultimate anti-paper money or the anti-fiat currency store of value since it represents a form of money that cannot be printed by central banks. To further highlight how we combine global diversification and a dynamic, tactical approach to managing our portfolios, let's look more closely at gold as an asset class since it is an integral part of the 3EDGE investment universe. At times gold seems to be an asset class that critics love to hate. It doesn't pay interest or a dividend, and it costs money to store. However, like other alternative asset classes, gold can hold its value and even appreciate during periods of market turmoil and in particular during periods when equities may be declining. Therefore, over the long-term, both equities and gold appreciate, but importantly they tend to zig and zag at different intervals. Also, gold can serve as an effective shock absorber and as a haven asset during periods of extreme market uncertainty. The shock absorber effect of gold is an important reason why each of our 3EDGE strategies will always hold at least some gold in their portfolios at all times. Gold is an excellent example of an asset class that plays a vital role in creating four-wheel-drive portfolios that are intended to get our clients through both thick and thin.

Four-Wheel-Drive Portfolios.

At 3EDGE Asset Management we offer investment portfolios that are broadly diversified at all times, and we utilize our model research to inform our tactical allocation decisions which dictate the weightings of the various asset class holdings for each unique strategy. Currently, as a result of our model research, we are closer to our minimum holdings in U.S. equities while at the same time we are nearer to our maximum range in our allocation to gold. After decades of study of the global capital markets, we consider our approach as more prudent and more effective in delivering attractive risk-adjusted returns than having to choose between being all-in or allout of the market, which we would consider akin to market timing, an approach that our research has shown does not necessarily serve investors well.

3EDGE proprietary research model.

Our approach to model research is three dimensional, in that we model economic and market fundamental factors, valuation factors as well as investor behavior. (See the chart below). In addition, our model solves simultaneously across CAGR (Compound Annual Growth Rate), Sharpe Ratio (returns relative to volatility/risk), and Maximum Drawdown (potential maximum peak to trough loss) for the various asset classes that make up our investment universe. In keeping with our four-wheel-drive analogy one might consider our dynamic/tactical management of our strategies to be the steering mechanism to our four-wheel-drive vehicle as we seek to tilt towards more or less exposure in the various asset class ranges, based upon our model research, as well as the risk and return targets for each strategy. This combination of broad global diversification and dynamic tactical portfolio adjustments is designed to deliver four-wheel-drive portfolios, intended to smooth volatility and manage downside risk and thereby allowing investors to remain invested through both up and down markets.

Positive Drift can also be beneficial over the long-term.

Another reason that maintaining globally diversified portfolios at all times can make sense is because of something that we refer to as positive drift. Positive drift simply refers to the fact that over long-time horizons, all of the well-known investable asset classes in our investment universe tend to increase in value over and above the rate of inflation. See the chart below, which shows the average annual return for a wide variety of asset classes beginning in 1972 through June 30, 2019.



As we go further into late-cycle equity market behavior, and volatility and risk continue to rise, investors shouldn't have to choose between being all-in or all-out of the equity markets. At 3EDGE Asset Management we offer an alternative investment solution that is always diversified, tactical and explicitly designed to get investors through both up and down markets by seeking to manage volatility and reduce overall portfolio risk. The ultimate goal is to help Advisors and their clients to remain invested through both up and down markets, therefore providing the best possible chance of achieving their investment and financial goals. Adding one of 3EDGE's strategies as a sleeve to a client's overall mix of investable assets may serve to reduce volatility and risk, and potentially be additive to returns over the long-term. Therefore, the 3EDGE investment strategies may be an excellent complement to other investment strategies that make up the totality of a client's investable assets.


DISCLOSURES: This Commentary is provided to current and prospective clients of 3EDGE Asset Management (“3EDGE”) for informational purposes only. The opinions expressed in this Commentary are those of 3EDGE and are subject to change without notice in reaction to shifting market conditions. 3EDGE's opinions are not intended to provide personal investment advice and do not consider the investment objectives and financial resources of the reader. Information provided in this Commentary includes information from sources 3EDGE believes to be reliable, but the accuracy of such information cannot be guaranteed. Investments including common stocks, fixed income, commodities, and ETFs involve the risk of loss that investors should be prepared to bear. Past performance may not be indicative of future results.