Advisor Update December 2016 - The Most Bizarre Capital Markets Months Ever

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Advisor Update December 2016 - The Most Bizarre Capital Markets Months Ever

November 2016 will go down as one of the most bizarre capital markets months ever. In the wake of a real live "Dewey Beats Truman" in US election results, almost every major defensive position was crushed by speculation on the economic plans of a Trump administration. Long-duration bonds, interest-rate-sensitive equities, and gold were hit hardest, and in the midst of the carnage a massive dollar rally put fuel to the pyre. But there are and were contradictions everywhere—a prime example is that the velocity of the dollar rally was similar to "crisis" events where the currency is being used as a "safe haven." High yield credit, which tends to move in correlation with equities, was overwhelmed by its interest rate sensitivity and was thrown out with the rest of the bonds in the bathwater. Finally, it's incredible to assume market participants can know how a Trump economy would play out—as if the most radical changes in government policy in decades can be known and discounted before they are even made clear, let alone pursued. We made our tactical and “look-ahead to 2017” moves at the beginning of this month and have recovered a great deal of the carnage-related performance.

We are a tactical allocation firm which utilizes fundamental research, a monthly portfolio review process and is focused on risk management. Our outperformance over our tactical allocation peers over the last five years is due in large part to this careful and crafted process focused on fundamental facts that monthly and longer datasets tell us about the direction of asset prices.

What we can do is separate the speculation from the facts:

  1. The strongest signals about the markets' direction came just prior to our December Portfolio Meeting with the appointments of Wilbur Ross as Commerce Secretary and Steve Mnuchin as Treasury head. Both are no-nonsense deal makers with plenty of restructuring experience. I think it's funny that many pundits criticize that realm of expertise but the truth is that bankruptcy is one of the best training grounds for financial expertise—every dollar means something and all stakeholders have to cooperate and compromise to stay alive.
  2. Mnuchin is a "bond guy", and he's very likely to look at the current US treasury obligations as a huge opportunity to push out maturities in big way to finance fiscal investment. Even after the rout of the last few weeks, the US 30 year rate is only 3.16%; I'm sure that 50 and even 100 year maturities are being considered. This probably means that growth through investment will finally be a reality and that is sorely needed in US.

  3. Yes the deficit hawks will be screaming, but if we don't fix crumbling infrastructure, long-term trend economic growth will continue to grind lower. I trust in capital markets folks to manage the US balance sheet more than politicians and career bureaucrats. They gave us a huge deficit, no tax reform, no infrastructure investment—to use the President-Elect's phrase: "What do we have to lose?"

In our view there are some trends that will play out over the next year:

  1. After two years of struggling to make new highs, US Equities will finally have a chance to "finish" the post-2009 bull market with the support of fiscal stimulus and regulatory reform. Small cap stocks should outperform large caps, as higher bond yields will compete with dividend-oriented equities. Financials (our strongest conviction), industrials, and materials should benefit from a Trump administration, and we continue to favor technology, which is far more embedded in the aforementioned sectors than five years ago. High-dividend stocks may come under pressure as income oriented investors’ options increase in a higher interest rate environment.
  2. Just as investors must be careful with their sector exposure in the US, they too must be careful with their country selection abroad. The EU is resetting politically, and financials will likely continue to thrive with ECB liquidity measures. There will be select and tactical regional plays available there but until the Italy/France/German elections play out, it's a risky region, and Brexit, along with the November Trump surprise, have made it more so. Additionally, we have exposure in Japan, Canada, and Australia where fiscal and monetary policy are aligned.
  3. China is a mess and its own reset is hurting emerging markets all over the world. A stronger dollar exacerbates these forces, and is especially hard on countries struggling with current account balances. There will be pockets in the emerging market world which will do well if the dollar run takes a pause, and we will be alert for opportunities.
  4. Fixed income markets will be more volatile. We think high yield credit and preferred stock will be winners in the US market. Treasuries and sovereigns will be a hard sell in what hopefully (after the speculative fury of the last few weeks subsides) will be a slowly increasing yield environment in the face of realized growth and inflation. Long-term bond bulls point to as evidence that the US and global economies are fated to ever slower and fragmented growth. If "Trumpflation" fails, it will be just a blip on this long journey. That's not a 2017-18 issue as we plan our positions.

One month does not make a trend, but there are some useful signposts. We will be pointing the way in our tactical allocation portfolios, as you have come to expect over the last decade.

John Forlines, III

JAForlines, LLC

Investment Management

Past performance is no guarantee of future results. The material contained herein as well as any attachments is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies, opportunities and, on occasion, summary reviews on various portfolio performances. Returns can vary dramatically in separately managed accounts as such factors as point of entry, style range and varying execution costs at different broker/dealers can play a role. The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts are inherently limited and should not be relied upon as an indicator of future results. There is no guarantee that these investment strategies will work under all market conditions, and each advisor should evaluate their ability to invest client funds for the long-term, especially during periods of downturn in the market.

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