Last week on our podcast, I spoke with Bruce Lavine, my former boss and colleague and current member of the WisdomTree Investments board of directors, along with his current colleague John Davi, founder and CIO of Astoria Portfolio Advisors. We had a great conversation on Lavine’s background and history, going back to his early days at WisdomTree and the founding of the iShares business. The discussion with Davi touched on portfolio themes Astoria has worked into clients’ exchange-traded fund (ETF) portfolios for 2018.

In March of this year, Davi saw a dream scenario for stocks: earnings were inflecting higher globally, liquidity was tremendous and inflation was muted. This led him to invest in emerging market equities, emerging market currencies, U.S. cyclicals, Europe and Japan. As he looks ahead, this bullish outlook has become more of the consensus. Davi now is looking for ideas that are out of consensus that he can time and size right for his portfolio in order to outperform. He still is constructive on the market for the next quarter, with over-weights in U.S. cyclicals, global ex-U.S. equities and international small caps.

Liquidity Declining: Due to the Fed’s planned rate hikes, quantitative tightening and a likely pullback in liquidity from other central banks such as the European Central Bank, Davi expects liquidity to decline on the margin. Davi said that markets trade on the margin and the rate of change is everything, so this decline in liquidity will have significant portfolio implications. As a result, Davi suggested holding portfolio-diversifying assets such as liquid alternatives, gold and long dated duration in order to lower portfolio volatility.

Fixed Income out of Benchmark Exposures: We also discussed whether the negative correlation between equities and bonds will persist over time, and Davi commented that the bond market over the last 30 years was like Christmas for his kids—bonds provided income, carry, diversification and hedging properties. But with the more than $2 trillion of inflow into bonds over last seven or eight years, he no longer sees bonds as a risk-reduction tool or high income. Davi does not like making a bet on the belly of the bond curve; instead, he uses municipal bonds, senior loans, emerging market debt and preferred equity for their income, where they each provide two times the yield of the traditional Bloomberg Barclays U.S. Aggregate Bond Index. Davi mentioned that neither of these provides the opportunity they did years ago, but there is a small margin of safety compared with traditional bond indexes.