Markets in Motion - May 1st 2017

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Macro Backdrop:

We have been asked many times over the past several years when, if ever, the period US equity outperformance vs. the rest of the world would finally come to an end. We typically responded that there were a lot of reasons to favor US equity, as we did in our portfolios. The opposite may now be true, and lagging performance of US equities year-to-date supports this thesis. If we are correct, we may be entering a multi-year period of international equity outperformance, and investors would do well to allocate to this tailwind.

First, in order to support a long-term period of out-performance of one equity market over another, the fundamentals must be in place. These exist in spades. Outside the US:

  • Equity valuations are more favorable
  • Profit margins are narrower, so companies face less margin pressure
  • Foreign currencies, in general, are undervalued on a real basis
  • Monetary policy, broadly speaking, is more accommodative—yield curves will have a steepening bias in the coming years, as opposed to a flattening bias in the US

One can argue fundamentals until they’re blue in the face, but fundamentals don’t exert influence if shorter-term conditions are unfavorable. This has been the case for years: international equities have been plagued with myriad reasons for investors to avoid them. Poor economic growth, poor earnings growth, uncertain monetary policy, unstable political conditions, and countless other crises have served as scare factors. Meanwhile, the US has represented a bedrock of policy certainty and economic and earnings growth. But now the shoe is on the other foot. Economic and earnings growth have accelerated abroad while remaining weak in the US. Monetary policy in Europe and Japan will remain ultra-accommodative for years, while Janet Yellen’s replacement remains a question mark. And political stability looks set to return to Europe for the first time in years, just as political instability has arrived in the US. We have captured significant international equity outperformance year-to-date, and have positioned our portfolios to continue to do so.

  • 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.
  • After Emmanuel Macron’s first round victory in the French election, we are more confident in our view that European politics will move away from populism and nationalism this year, 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. With the threat of a disruptive French election nearly behind us, we expect the Yen to resume weakening.
  • 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 market equities continue to benefit from positive capital inflows and represent attractive relative value.
  • 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.

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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