The global financial system clearly looks better than it did just a few years ago when the world’s largest banks and many governments found themselves in deep trouble in the midst of the worst recession since the Second World War. But lately conditions have improved and many of the larger equity markets are trading at or near new all-time highs. In recent weeks, US consumer confidence has been reported the best in five years. Overall, companies are announcing better earnings each quarter causing investors to feel more confident in the financial markets and perhaps greater optimism about their own financial position.However, the question of day remains: where do we how go from here? Interest rates are still hovering near record lows, money market funds are safe but are probably not keeping up with inflation and the sharp stock market rally we have seen this year has created concern over stock price values. Investors who were left behind by being too conservative are also likely wondering if it is too late to catch up.No two economic cycles are exactly the same, but what makes this economic recovery somewhat similar to those in the past is that the US is once again leading global growth. Although China and the other emerging markets were instrumental in pulling the world out of the 2009 economic contraction, lately those economies have lost steam. In particular, China’s new leaders have taken steps to reign in credit growth causing its economy to soften. Picking up the slack, America’s highly accommodative Fed has been a key driver in moving equity markets to higher levels this year.Looking around the world, economic progress is better than before but remains uneven. Japanese growth has seen a big improvement this year after being stoked by newly elected Prime Minister Shinzo Abe’s highly aggressive fiscal and monetary programmes. However, the island country’s rapidly ageing population and massive government indebtedness make the sustainability of its recent growth surge suspect. Across the Atlantic, Europe remains stuck in neutral as the Southern European nations struggle with austerity and high debt levels. That leaves the US as the engine most likely to pull the world out of its slump.To put things in perspective, the US represents approximately 21 percent of the global economy. Of the total composition of America’s gross domestic product (GDP) growth, approximately 70 percent of this amount is comprised of consumer spending, putting the American consumer at 15 percent of global GDP. Therefore, to improve the US economy, the challenge of America’s Fed has been to get the consumer back into the game, which by default would help the global economy along. The series of QE programmes implemented over the past few years were designed to infuse the system with money and put the real estate market back on track. While real estate in itself is not a huge component of GDP, the sector creates jobs such as those in construction and better home values cause people to feel more optimistic about their personal net worth.It took some time, but the Fed’s strategy appears to be bearing fruit. In recent months, consumer confidence and personal spending have been on the upswing largely through an improvement in the so-called ‘wealth effect’. The wealth effect is an economic concept which implies that the higher the value of the consumer’s personal net worth, including retirement accounts, savings plans and home prices, the greater the likelihood those consumers will spend money. The free flowing of goods and services is what creates jobs and ultimately lays the groundwork for a ‘self-sustaining’ recovery no longer dependent upon central bank capital injections.By most measures, America’s residential real estate market is making a comeback just as the stock market has been hitting new highs. Higher market values are helping boost the ‘wealth effect’ and therefore consumers are showing signs of life again. But can it continue?At this point in the market cycle, we believe it more important than ever to consider the big picture in structuring investment portfolios. Most importantly, asset allocation is a critical decision. While profitable tactical moves can add significant juice to total returns, staying on course requires attention to strategic discipline.To move things forward, every investor should have a sense of their goals and use this to draft an Investment Policy Statement (IPS). The IPS should provide a clear outline of the person or institution’s investment objectives and restrictions including, risk tolerance, time horizon, applicable tax rates, legal considerations and income needs. From there, an initial asset allocation strategy can be determined which falls along the empirically derived ‘Efficient Frontier’, or a portfolio that is expected to optimally achieve the highest expected return for a given level of risk.The asset allocation strategy should have flexible ranges for each class asset class allowing any particular asset to be over or underweighted on a short term or tactical basis. In assessing such tactical moves, we emphasise a ‘top-down’ outlook for the economy and with respect to each asset’s relative valuation against its historical past and other assets.An example of one of our present tactical directions is being overweight equities but with a focus on higher quality, income-producing securities. Our equity portfolios are heavily weighted towards those companies which pay regular dividends that are sustainable and growing, operate with a clear market leadership position and are experiencing stable or improving fundamentals. In the LOM Stable Income Fund for example, the average stock dividend yield in the portfolio is more than twice the dividend yield of the S&P 500 stock index.With markets at new highs, we also suggest holding back a cash position. If we do see a selloff in the equity markets, those funds can be used to buy more of the same high quality companies at a better price.Other tactical moves include overweighting American equity markets on the premise that the US is still the ‘best house in a tough neighborhood’ and being overweight the healthcare sector. In the fixed income market, we are invested in select issues backed by the several of the more creditworthy newly industrialized countries and asset-backed securities which offer attractive relative income and total return potential.Bryan Dooley, CFA is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.