By John Eckstein, CIO, Astor Investment Management
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 changein 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.