K2 Advisors seeks to add value through active portfolio management, tactical allocation and diversification across four main hedge strategies: long/short equity, relative value, global macro and event driven. In their fourth-quarter (Q4) 2017 outlook, K2 Advisors’ Research and Portfolio Construction teams share the key market events they have an eye on. We believe offering these insights will help investors better understand the rationale for owning retail mutual funds that invest in hedge strategies.

Two Sides to Every Story—and the Truth

In a recent Bloomberg interview, legendary investor Howard Marks of Oaktree Capital said that investing is “never black or white, in or out, risky or safe.” He suggested that investing is about continually calibrating your portfolio across a spectrum of risk—from aggressive to defensive. We could not agree more.

The media likes to hear market calls. They like pundits who say “get out now,” “buy now,” or “it’s time,” etc. We don’t believe anyone can ever be that certain. Most of the time the correct action is somewhere in between. We can never know what the future will hold, but we can get a sense of potential outcomes by looking at what the past gave us, and where we stand in the present. The amount you have invested, your exposures across various asset classes and sectors and the presumed riskiness of each in the context of the current market. These are all things we can consider.

So where do we stand today? From our perspective things are looking a bit frothy. Again, this is not a market call. This rally could continue on for another year or even longer—who could know? What we do know is where we are relative to historical context.

Consider the equity markets, for example. The chart below shows the Cyclically Adjusted Price-to-Earnings ratio (CAPE), which is a way of assessing the value of stocks in the S&P 500 Index.

The CAPE has only been this high three times before: 1929 (leading to the Great Depression), 1999 (during the dot-com bubble), and in 2007 (during the housing bubble leading up to the Great Recession).