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Markets In Motion - June 2017

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Macro Backdrop:

As if last year’s Brexit vote wasn’t enough to demonstrate the UK’s political unpredictability, Theresa May’s recent gambit to increase her parliamentary majority backfired in spectacular fashion. Jeremy Corbyn’s Labour party nearly overcame a lead measured at 25% less than two months before the election to spoil May’s victory. She was forced to form a parliamentary coalition with the Northern Irish Democratic Unionist Party in order to form a majority and avoid a hung parliament. This weakens her hand in Brexit negotiations and will force her to steer the UK more towards a “soft Brexit” than a “hard Brexit.” The hardline conservatives which make up much of her party will refuse to support such a shift, and she risks losing a vote of no confidence which would remove her from power. What a mess.

On the other side of the Channel, the political environment could not be more different. Emmanual Macron has secured a landslide victory in French parliamentary elections, winning 350 seats in the 577 member National Assembly. This gives him a mandate to pursue his policy agenda. With French and German policy philosophies in strong allignment, the political will is now in place to institute meaningful reform to promote economic and financial stability in the Eurozone.

Meanwhile in the US, we continue to be concerned about stagnating corporate credit creation. Typically businesses curtail borrowing after a yield curve inversion (when short-term rates are higher than long-term rates). An inverted yield curve indicates that borrowing costs are greater than long-term returns on capital. However, despite some recent flattening, the yield curve remains steep by historical standards. Furthermore, financial conditions are supportive of continued economic expansion. We therefore do not expect a sharp deterioration in US economic activity this year, but will keep a very close eye on this important indicator that is now flashing yellow. As a result, we continue to favor international equity over the US.

  • We are avoiding foreign currency fixed income to benefit from higher US dollar interest rates. We expect spreads between US dollar and foreign currency interest rates to narrow, and therefore will benefit by concentrating all of our fixed income exposure in US dollar denominated holdings.
  • Our fixed income portfolio adopts a barbell approach: we own long-duration sovereign bonds counterbalanced by high yield bonds and preferred stock. This gives our portfolios extra exposure to cyclical assets, while still maintaining a relatively high portfolio duration.
  • Our US equity exposure is limited to four sectors: financials, technology, biotech, and aerospace & defense. Financials benefit directly from a higher interest rate environment in the US, as well as a more favorable tax and regulatory environment which is likely to develop. The pace of disruption of old industries by new products and processes has continued to accelerate, and technology and biotech give us exposure to this process of creative destruction. US allies will likely increase their military spending in coming years in response to the Trump administration’s perceived unreliability—the aerospace and defense industry will be a beneficiary.
  • 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.
  • Following the French parliamentary elections, we have reaffirmed our view that European politics will move away from populism and nationalism this year. This will enable European policymakers to implement reforms necessary to bring stability to the Eurozone and assuage fears of redenomination risk that have plagued the continent. This would support the Euro and European equites, 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. However, the Yen has rallied in 2017 as investors have sought its safe haven status. With the threat of a disruptive French election nearly behind us, we expect it to resume weakening.
  • Emerging market equities continue to benefit from positive capital inflows and represent attractive relative value. Furthermore, we expect Fed policy to ere on the dovish side as the year goes on, which will support emerging markets. We have recently increased this position
  • 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
AdvisorRelations@jaforlines.com
www.jaforlines.com

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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.

| Categories: Articles | Tags: Europe, Politics, Credit | Return

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