March 31, 2021

All investors face capital-market risk. Managing that risk, evaluating opportunities in the context of an investor’s goals, and assessing specific investments efficiently requires broad, objective, close-to-the-capital-market thinking. An asset allocation framework does not need to be a black box that processes many statistical variables and then spits out an investment plan. It should be a logical framework that lays out choices for investors. The arguments presented here lead us to conclude that the US is likely to outperform the rest of the world. The degree of outperformance will depend on how the rest of the world reacts. Nevertheless, the US recovery and higher rate of return will attract domestic and foreign capital. The foreign capital inflow will result in a dollar appreciation over and above the purchasing power parity. That is the US terms of trade or real exchange rate will appreciate long as the US terms of trade is above the PPP line. Finally , since larger cap tend to be multinational companies and the small cap are more likely to be domestic companies, we expect the dollar appreciation to favor the smaller capitalization stocks over the larger capitalization stocks.

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