We are proudly initiating a simple three-asset portfolio today. The purpose of this exercise is to keep our readers apprised of our medium-term outlook for the broad traditional classes of financial assets (global equities, investment-grade fixed income and cash equivalents) at any particular point in time. Our tactical allocations to each cohort contain information regarding our views toward the asset class’ absolute and relative medium-term prospects (we define medium-term as 2-3 months in this context).

Our momentum reversal work, the linchpin of our approach to asset management, will guide the positioning of this hypothetical portfolio.

We settled on the iShares MSCI ACWI ETF ($ACWI), the iShares Core U.S. Aggregate Bond ETF ($AGG) and the SPDR Barclays 1-3 Month T-Bill Index Fund ($BIL) as our stocks, bonds, cash proxies.

For attribution purposes, we will compare this model to a floating-weight benchmark portfolio comprised of 60% $ACWI, 30% $AGG and 10% $BIL. Further, we allow ourselves the latitude to over- or underweight stocks and bonds by up to 10% of the policy portfolio weights. This implies that equity exposure will range from 54-66% (calculated as the 60% benchmark equity weight x  [100% ± 10%]). Similarly, the fixed income allocation will vary between 27-33% (30% x [100% ± 10%]). And, by default, the model will hold as little as 1% cash equivalents, or as much as 19%.

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Mosaic Theory Letters Tactical Asset Allocation Model — May 25, 2016

Our inaugural medium-term allocation features a max overweight to global stocks, consistent with the pro-equity bias we expressed back in mid-March. In the piece two months ago, we speculated that the condition of medium-term momentum for $ACWI likely foreshadowed price gains into late-May. 10 weeks later, upside targets have been captured for many equity indices and medium-term momentum indeed appears stretched. As such, we expect to pare the allocation to stocks perhaps as soon as within the next week or two. In spite of our growing caution regarding equities though, we remain medium-term stock market bulls until we observe more solid evidence of an inflection.

Our momentum work turned medium-term constructive on investment-grade fixed income in early-January, in time to catch the most of the massive contraction in credit spreads experienced year-to-date. Four and a half months later though our model is wary of bonds, prompting us to adpot a max underweight to fixed income. We would not be surprised to see rates continue to grind higher in days and weeks ahead, and we are concerned about the impact on corporate credit spreads of a potential medium-term correction in energy prices. Accordingly, we are light in the fixed income department.

And finally, while the 3% underallocation to bonds partially funds the overweight to equities, cash is likewise required to fully express our optimism toward stocks. After pegging the stock and bond allocations to our current perspective, a 7% allocation to $BIL remains.

Stay tuned!!

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