Asset allocation is when an investor divides their portfolio amongst various asset classes into percentages based on their individual time horizon and risk appetite. It used to be quite normal for one to diversify their portfolio and maintain a “buy & hold” strategy with the occasional re-balancing. However, this old style diversification that once was instrumental in reducing volatility risk has become harder and harder to achieve due to global markets which often move in sync with each other more and more over the last decade. In order to choose the asset allocation strategy in a portfolio, one must have a deep understanding of the global macro picture today. Further to this, faster moving global markets dictate that dynamic changes to the asset allocation should be more frequent and some times more drastic than it used to be.

Macro Picture

We are in unprecedented economic territory after the giant credit bubble collapse starting in 2008. Though we have experienced credit crunches in the past, this one is bigger and is intertwined with many important developed countries increasing the risk of global contagion. The natural course after a credit crisis is massive re-payment of debt, known as de-leveraging. This de-leveraging on a massive scale can induce a deflationary environment. Deflation is bad and painful because spending, both on a corporate level and personal level, slows to a crawl. In turn we suffer from asset value declines and eroding personal wealth all within a high unemployment environment. Governments are using almost all of the tools in their tool boxes to avoid a full blown deflationary scenario. To counter deflation, governments are trying to stimulate their respective economy’s by using tools that might reflate it.

Follow the Money & the Spenders

Follow the money, but first, follow the spenders. Economic “good times” are often the result of one or more major spenders. Sometimes it’s the corporations that spend and invest and basically spread money around. Over the last many years it has been the consumers who have spent, which also spreads the money around the economy creating growth. Right now the major spenders are the governments. But are they spending in the right places in order to spread that money around? There is a fine line with developed nations swelling their debt to unprecedented levels in order to spur the economy. At some point the effort has to start working because increased debt levels will become unsustainable. We don’t want the kind of debt problem which can lead to government defaults because then the tool box gets thrown out the window and the machine guns come out. This could mean many things none of them pleasant. Extreme examples could be government confiscation of assets such as gold, a global race to currency devaluation (excess printing of money), government default on debt, trade wars, or outright world wars. Such things have happened before, and hopefully policy makers don’t let things get that far.

Now, follow the money. The next wave of spenders will be the ones with the healthiest balance sheets. So far it looks like the corporations who have shrunk their debt loads, cut expenses to the bone, and who now have swelling cash balances waiting to be spent. But they’re not spending. This corporate cash hoarding seems to be the new vogue. They are not spreading the money around to help create economic growth. Perhaps the governments need to focus their attention on using tools to spur a round of corporate spending. Instead it seems that they are trying to get the consumer to spend by offering various incentives like “cash for clunkers”. People with high debt don’t need new cars, they need jobs. Those that do have jobs, need to feel “job security” before they spend money on a new car. Those incentives, in my opinion, were political showcasing to make it look like they cared about Main Street. Seriously it’s like trying to make your cat act like a dog.

Growth or Recession?

The great debate happening amongst many analysts that I follow is whether the US and Euro zone are heading into a great deflation, a double dip recession, or just a very slow recovery. There are very few respectable economists that are looking at the global economic health very positively and the bond market seems to be pricing for a deflationary environment. On Friday July 2nd I was watching BNN and listened to a trader in New York talk about how many of the traders that morning simply came into the office (instead of taking an extra long weekend) in case they had to potentially hit the “sell button”. It’s like they are waiting for any sign of a sell off in the market to un-load their positions. That makes me nervous, yet cash heavy clients would benefit from the aftermath. It’s those investors out there who came into this powerfull bull market late in the game and are fully invested that will get hit the hardest if we do go through another downtrend in the market.

Asset Allocation

There are more signs of trouble than glory at this time, and I suggest an asset allocation shift to be very defensive at this time.

25% – 50% Cash equivalent investments
20% – 40% Canadian dollar fixed income (preferred shares, GIC’s, Government bonds)
10% -55% Dividend paying large cap stocks with good business models, little debt, and good cash flow.

The more conservative investors should go for the higher percentage of cash, and the least percentage in stocks. Investors should also be prepared to re-shift their allocation to take advantage of any market opportunities down the road.

Susan Mallin works with MGI Securities as a Toronto-based investment advisor. As an investment advisor at MGI Securities, Susan is able to offer clients a full suite of investment services and investment products. Her process was designed to guide clients through a sea of choices in order to help them make decisions, in a manner that is simple yet effective, throughout the journey of reaching their financial goals. Susan’s investment practice isn’t focused on account size or age. It’s about desire, attitude and willingness to succeed.

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