Perhaps the biggest lesson from last month is that all asset classes went down together. Similarly, it’s likely that as the economy “reflates” due to lower rates and rock-bottom valuations, all asset classes should rise in tandem. Deciding which has the largest upside potential is a tricky endeavor.

From a valuation standpoint, bank loans appear to be the cheapest asset class. Many loans are priced for a worst-case scenario, and trade at less than 60 cents on the dollar. But with few natural buyers and the market for leveraged loan portfolios like CDOs and CLOs all but shut down, it’s a bit difficult to make an argument to be the first ones in this trade.

High-yield spreads have certainly widened, but they not reflect the sudden increase in bankruptcies that accompany economic slowdowns. Bankruptcy rates have been kept artificially low by a loan market that has bailed out trouble firms by putting their credit in the equity portion of leveraged structures, but that game is all but over.

Global fixed income is appealing. With a rush to lower rates, investors will likely earn an attractive return on government debt in countries where rates have far to fall, but one should hedge against a rising dollar.

Equities seem to be the easiest way to play the recovery to less volatile markets. Not only are valuations attractive, but in the context of extremely low rates stocks have little competition from other asset classes. They should certainly be the majority of any diversified portfolio going forward. As always, a blend of investments is the safest and sanest way to position oneself going forward.

The Monthly Index Report for November 2008

Index

Oct 08

QTD

YTD

Description
S&P 500 Index*

-16.8%

-16.8% -34.0% Large-cap stocks
DJIA*

-14.1%

-14.1%

-29.7%

Large-cap stocks
Nasdaq Comp.*

-17.4%

-17.4%

-35.1%

Large-cap tech stocks
Russell 1000 Growth

-17.6%

-17.6%

-34.3%

Large-cap growth stocks
Russell 1000 Value -17.3% -17.3%

-32.9%

Large-cap value stocks
Russell 2000 Growth

-21.7%

-21.7%

-33.7%

Small-cap growth stocks
Russell 2000 Value

-20.0%

-20.0%

-24.3%

Small-cap value stocks
EAFE

-20.2%

-20.2%

-43.3%

Europe, Australasia & Far East Index
Lehman Aggregate -2.4%

-2.4%

-1.7%

U.S. Government Bonds
Lehman High Yield

-15.9%

-15.8%

-24.4%

High Yield Corporate Bonds
Calyon Financial Barclay Index**

4.9%

4.9%

8.9% Managed Futures
3-mo. Treasury Bill*** 0.2% 0.2%

2.4%

All returns are estimates as of October 31, 2008. *Return numbers do not include dividends.

** Returns are estimates as of October 30, 2008.

Ben Warwick is CIO of Memphis-based Sovereign Wealth Management. He can be reached at ben@searchingforalpha.com.