Article on Asset Allocation

Gavekal published an article several years ago on a framework on asset allocation. It basically uses prices and economic activity to classify the state of the economy and decides the correct asset to invest in.

If prices are raising/dropping the model classifies the economy as inflationary/disinflationary. If economy is expanding/contracting, the model classifies the economy as booming/busting.

See the model below:

Source: Gavekal - How Asset Allocations Adds Value

1) Scenario 1 - Inflationary Bust
In this scenario, interest rates will increase and generally equities and bonds will not be performing. The model recommends selling these financial assets and holding cash in safe haven currencies (CHF, SGD).

2) Scenario 2 - Inflationary Boom
In this scenario, bonds and interest rate sensitive stocks should be avoided. It is possible that this scenario is caused by central banks pushing too much money into the system. The real beneficiaries of this environment are "real assets" such as commodities like silver and gold.

3) Scenario 3- Disinflationary Boom
With oil prices moderating to 60-70 USD per barrel, major developed economies are in a disinflationary environment. Equities will do well in this environment. This explains the run up in equities prices around the world in the past two months.

4) Scenario 4 - Disinflationary Bust
Due to a weak economy, interest rates remains low and bonds typically do well in such an environment. All other assets generally will not do well.

Personally, I think the world's economy for the next three years will be either in Scenario 2 or 3. Its time to allocate/shuffle one's asset and position them in the correct instruments.