In asset allocation and investing, there is a natural tension between reacting and overreacting. The goal is to ensure you are skilled at the former, while avoiding the latter.
At Astor Investment Management, we believe our macroeconomics-based approach to asset allocation helps us react to what we determine to be real change in the economic trend. We reduce equity exposure (beta) when the economic trend weakens, and increase equity exposure as the economic trend strengthens.
What we don’t do is react to every little wiggle in a particular number. We often try to make this point in discussions with clients who may want to know what a particular “headline number”—be it GDP or the unemployment rate—means for investing. Our answer is that one number doesn’t make a trend. Rather, we use our proprietary Astor Economic Index® (AEI) to guide our asset allocation decisions.
The AEI is designed to take a series of employment and output data and aggregate them into a single number. We think of this approach as taking a snapshot, in real time, of the economy; it is a “now-cast”—not a forecast—because we believe it is not possible to forecast recessions. The often-quote joke in finance (attributed to Nobel laureate and economist Paul Samuelson) is that the stock market has predicted something like nine out of the last five recessions.
Instead, we use AEI to gauge the strength or weakness of the current economic trend and then invest accordingly. We predicate this approach on a central insight drawn from our research into nearly 100 years of stock market returns, dividing those years into months when the economy was in expansion on the first day of the month and months when the economy was in recession on the first day of the month. On average, during periods when the economy was expanding, the stock market gained an average of 90 basis points (0.9%) per month. Conversely, when the economy was in recession, the stock market lost an average of 75 basis points (0.75%) per month.
These research findings underscore the importance of gauging and reacting appropriately to the economic trend. For example, when we are confident that the economy is in recession, as indicated by the AEI, we steadily and quickly reduce equity exposure and add more fixed income. During times when the economic trend is positive, we typically add equity exposure.
But we don’t make such moves arbitrarily or in reaction to one or two numbers. We use the AEI as a powerful tool for asset allocation and to help us stay the course even when the stock market appears to be overreacting to some number—for example, during stock market drops that are likely to be transitory during economic expansions. The stock market might sell off sharply for a short time, but if we see no change in the economic fundamentals, we will stay the course. In those instances, when the stock market comes back a short while later, we’ll give ourselves a little pat on the back for protecting our clients by avoiding overreaction. We don’t take credit for being “right”; rather, we credit the AEI and the discipline it infuses.
The most important investment decision, of course, is determining the ratio of stocks and bonds. At Astor, our rationale is driven by economic fundamentals. By using the AEI, we can discern the economic trend through the noise the data.
All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.
The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.