Markets In Motion - April 12th 2017

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Macro Backdrop:

US equity markets shrugged off the Republican’s failure to pass healthcare reform surprisingly well. Healthcare reform isn’t extremely important for the “Trump reflation rally,” and the expectation that focus will shift to tax reform has eased investors’ minds. We’re not sure such complacency is well founded. There are ~$500bn in cost savings that will now have to be “found” elsewhere in the federal budget—no small task, and something quickly being realized. But more importantly, the failure of healthcare reform demonstrates the difficulty President Trump will face in building a coalition out of a divided republican party. In addition, the Freedom Caucus’ successful defeat of the bill may embolden them to defy the Trump administration in other matters as well. As a result, we have continued to allocate our portfolios away from “Trump reflation rally” positions.

What makes the delay in policy implementation so important is that the Fed has already adjusted monetary policy as a result of the market reaction to Trump’s victory, hiking interest rates twice since the election, projecting two more hikes in 2017, and signaling that they intend to shrink their balance sheet this year. However, if expansionary fiscal policies aren’t forthcoming, it introduces the risk that the Fed is tightening policy too quickly. That risk can be viewed by both the recent flattening of the yield curve and in the decline in bank lending to corporations (shown on right). As a result of this environment, we feel that US equities outside of certain sectors no longer merit the valuation premium that they enjoy versus the rest of the world, and we instead favor international equities.

We have written extensively about the political backdrop in Europe this year, arguing that moderate candidates would prevail and have the chance to forge muchneeded reforms. This would represent a major tailwind for European assets, and we have positioned our portfolios accordingly. The most important election of the year takes place in France at the end of the month (polls shown on the right), and we expect to increase our European equity allocation if Emmanuel Macron can secure the presidency.

  • We are avoiding foreign currency fixed income to benefit from higher US dollar interest rates.
  • Our fixed income portfolio adopts a barbell approach: we own long-duration sovereign bonds counterbalanced by high yield bonds and preferred stock.
  • Our US equity exposure is limited to four sectors: financials, technology, biotech, and aerospace & defense.
  • We expect European politics this year to move away from the populist and nationalist forces that have caused upheaval in recent years, benefitting our positions in Eurozone equities and the European financial sector.
  • Japanese equities are supported by the Bank of Japan’s ongoing aggressive monetary easing, and we expect the Yen to continue its decline against the dollar this year, which would support our position in currency-hedged equities.
  • Australian equities are supported by expansionary fiscal policy. They also give our portfolio exposure to commodity prices, which we have very little of elsewhere.
  • Emerging markets offer attractive relative value, and capital flows have improved following the adverse credit conditions faced by those countries during the US dollar rally and interest rate increases since mid-2014.
  • Gold’s status as an alternative currency should support it as global central banks continue to pursue extremely aggressive policies and geopolitical risks remain elevated. Furthermore, as an asset with low correlations to most others, it helps lower overall portfolio volatility.

JFG Team
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. Some products/services may not be offered at certain broker/dealer firms.

*Some Emerging Markets allocation overlaps with regional allocations.
**Individual account allocations may differ slightly from model allocations.
^Excluding GTA’s 7% alternative and cash positions.

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