First promulgated by the smart folks over at PIMCO, the industry is slowly starting to embrace the concept of the “New Normal” age of investment returns. Simply stated, investors should expect single digit returns on average over the next few years while the developed economies dig their way out of the wreckage of the Global Financial Crisis. In a world of deleveraging, lower consumption growth, very low interest rates and maybe even a dash of deflation, investors are being told to ratchet down their expectations.

The elegance of the “New Normal” scenario is that it is self fulfilling. If one continues to invest like the 1990’s never ended, steady single digit returns are a very likely outcome. Buy and hold, quarterly rebalancing, broad diversification and closet indexing should give investors a pretty meager return if the overall economic pie doesn’t grow much. Unfortunately, this is precisely how most fund management, insurance and pension funds are designed to operate.

Why are we looking at crummy returns?

One need not look too far for the answer. While the global economy should experience some nice 4% plus growth over the next two years, the developed economies are not likely to enjoy anything approaching that level. Without several quarters of supercharged GDP growth, the US will be stuck with excess idle capacity and 10% unemployment. For investors who seek to get a broadly diversified exposure to the snail like growth of the US economy, it will be difficult to exceed the snail speed limits in terms of investment return.

How do we know that the US is in for more of the same?

The ECRI leading indicators are negative and while they are not deteriorating, they are not suggesting much in the way of growth either. Even the Mainstream Financial media is starting to figure out that neither more government stimulus nor Quantitative Easing 2 is going to be of much help. Without the private sector, the newly created money will cycle through the economy at a relatively slow rate, negating most of its stimulative properties. The Consumer Metrics Website is not painting a pretty picture either.

ECRI chart


What can one do?

The answer lies in asset allocation. Just because a company is headquartered in the US does not mean that all of its revenues and profits come from the US. And just because the overall economy is due for a sluggish performance does not mean that there won’t be pockets of strength to exploit. For this week, take a look at the SPDR Materials ETF (ticker: XLB). The ETF itself is showing some reasonable strength for the medium term but if we were to construct a portfolio of the 31 constituent stocks and apply the Fund King System, we can see that a good 5 year return (over 100%) turns into a very strong 5 year return (holding only 5 of the 31 stocks at any one time).

SPDR Materials ETF

This same concept of selecting a portfolio universe and then investing in the most promising part while selling or avoiding the part of the universe which is not as promising can be applied to a wide variety of asset classes. For investors willing to consider investing part of their portfolios in Turkey, India, Asia or Emerging Markets in general, the prospects look much brighter than what US and European markets are likely to dish up in the medium term. Of course, when the tides of money shift direction, the Fund King System will be there to flash that inevitable signal as well.

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