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Markets In Motion - November 2017

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Macro Backdrop

Early this year, we wrote frequently about the improving political environment in Europe, and the positive effect it would have on European asset prices and the European economy. We held large positions in European equities and benefited nicely following the Dutch and French elections. The French election in particular represented a major shift in European policymaking and offered the promise of a renewed drive to deepen regional integration and put in place the framework to prevent a repeat of the 2011/2012 debt crisis and secure the long-term viablity of the Euro. Unfortunately, our optimism was short-lived, as the recent poor showing by Chancellor Merkel in the German election made the prospect of positive policy initiatives much more complicated. Adding to this, support for the ruling Democratic Party in Italy has waned in recent months, creating the possibility of a very disruptive outcome to the 2018 general election. This deteriorating political environment has caused us to again reduce our European equity exposure, and for the first time since December 2012 we do not hold any targeted equity exposure to Europe.

Increasing risks in Europe represent only half of the motivation behind our shift in equity exposure, with increasing opportunity in Asia representing the other. After an incredible 14 years of contraction, Japan is finally experiencing private sector GDP growth. Corporate profit growth has also been strong, with corporate profits at all-time highs. Furthermore, the Yen and Japanese equities, which have long been highly correlated, have recently decoupled—a sign of the “goldilocks” conditions Japanese policymakers have finally achieved. We expect, once markets recognize these conditions, the Yen to appreciate substantially from its current deeply undervalued level, and have therefore unhedged all of our Japanese equity exposure.

2017-08-17-chart-3The other piece of our Asian equity exposure is to emerging markets, and in particular China. Emerging market underperformance in recent years was largely a commodity story, but East Asia is commodity poor. Asset allocators tend to paint emerging markets with a broad brush, and therefore these countries’ equity markets were unfairly punished. Now that the associated capital outflows have subsided, Asian equities have registered substantial outperformance, which we have been well-positioned to capture. In particular, Chinese internet firms have emerged as a rare opportunity. Following in the footsteps of the dominant US firms like Google, Amazon, and Facebook, these Chinese counterparts have achieved incredible rates of growth as they tap into an enormous Asian market. In total, we now hold the highest level of Asian equity exposure in the history of our Global Tactical Portfolios.

  • 2017-08-17-chart-3We hold a tactical cash position in our GTC, GTA, and GTG portfolios. While we remain constructive on equities in the intermediate-term, the short-term risk factors suggest to us that a more conservative approach is prudent for now.
  • 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.
  • We are avoiding long duration fixed income in our portfolios. Interest rates may rise in the 4th quarter as economic growth accelerates and global central banks step away from the “extraordinary measures” they employed during the financial crisis.
  • We have exposure to four US equity sectors: financials, technology, energy, 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 gives us exposure to this process of creative destruction. Revived economic growth will support global energy markets, and energy equities are under-owned by asset allocators, creating an excellent buying opportunity. Global military spending will increase in coming years, as US hegemony fades and a multi-polar world emerges—the aerospace and defense industry will be a beneficiary.
  • Japanese equities are supported by favorable valuations, accelerating economic and earnings growth, the Bank of Japan’s ongoing aggressive monetary easing, and global money managers are very underweight. We have recently exchanged our Yen-hedged position for positions in unhedged large- and small-cap equities to benefit from an appreciating Yen.
  • Japanese equities are supported by favorable valuations, accelerating economic and earnings growth, and the Bank of Japan’s ongoing aggressive monetary easing, and global money managers are very underweight. We hold positions in both hedged and unhedged Japanese equities in order to minimize Yen volatility.
  • Emerging market equities benefit from positive capital inflows and represent attractive relative value. We expect global capital flows to remain supportive and emerging market equities to continue to “catch up” after years of underperformance. Asia, in particular, represents an excellent opportunity.
  • Gold's status as an alternative currency should support it as geopolitical risks and policy uncertainty remain elevated. Furthermore, as an asset with low correlations to most others, it helps lower overall portfolio volatility.

Recent GTA Portfolio Changes

  • We have exited our remaining position in European equities. A disappointing result in the German election, and an uncertain outcome for the upcoming Italian election mean that risk now overshadows opportunity for European equities.
  • We have exchanged our Yen-hedged Japanese equity position for positions in unhedged large- and small-cap Japanese equities. We expect the Yen to appreciate from its deeply undervalued level as markets recognize that private sector growth and low inflation have taken hold.
  • We have increased our global technology exposure, focusing on US large cap and Chinese internet equities. Disruption of “old economy” industries continues at a furious pace, and exposure to this growth dynamic has rewarded us nicely.

GTA Portfolio Changes Since 7/31/2017

2017-08-17-chart-3Reduced portfolio duration to protect against rising global interest rates.

  • Global economic growth has accelerated, with all major countries now in expansion as measure by their PMIs
  • The Fed has begun reducing the size of their balance sheet, and intends to tighten policy as long as markets allow
  • The ECB has also signaled its intention to begin to tighten policy, though to a lesser extent than the Fed

Shifted US equity exposure towards “late cycle” sectors. As we approach the late stages of the credit cycle, our US sector exposure will naturally shift from high growth industries which benefit from low interest rates and inflation to sectors that benefit from higher interest rates and/or inflation, in this case financials and energy.

Shifted Eurozone and Australian equity exposure to emerging markets and Japan. We have therefore sought markets which offer better value and growth prospects, while also achieving exposure to countries which are earlier in their respective credit cycles.


Please do not hesitate to contact us with any questions!
Best regards,

JFG Team
JAForlines, LLC
Investment Management

AdvisorRelations@jaforlines.com
www.jaforlines.com

As of 10/12/2017.
July 30, 2017 out of 251 funds.
1Individual account allocations may differ slightly from model allocations.
2Some Emerging Markets allocation overlaps with regional allocations.
3Excludes GTA’s 7% alternative and cash positions.
4Contains international exposure

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. The investment descriptions and other information contained in this Fact Sheet are based on data calculated by JAForlines Global (JFG) and other sources including Morningstar Direct. This summary does not constitute an offer to sell or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities. This report should be read in conjunction with JFG’s Form ADV Part 2A and Client Service Agreement, all of which should be requested and carefully reviewed prior to investing.

The JFG Global Tactical Allocation Composite (“Composite”) was created on 1/1/2004. The JFG Global Tactical Conservative Composite (“Composite”) was created on 1/1/2004. The JFG Global Tactical Income Composite (“Composite”) was created on 9/1/2012. The JFG Global Tactical Growth Composite (“Composite”) was created on 2/1/2015.

Composite returns are calculated gross of investment management fees, net of investment trading expenses and underlying fund costs but does not reflect the effect of income taxes on the investment returns. Actual performance results will be reduced by fees including, but not limited to, investment management fees and other costs such as custodial, reporting, evaluation and advisory services. Performance reflects the reinvestment of dividends, income and capital appreciation. Composite returns are calculated monthly using the time weighted total rate of return methodology. Monthly returns are geometrically linked to calculate quarterly and annual returns. As fees are deducted quarterly, the compounding effect will be to increase or decrease their impact by an amount directly related to gross portfolio performance, and dependent on direction, magnitude, and order of returns. For example, on a portfolio with a 2% annual fee, if gross performance is 10%, and performance is equally distributed across all four quarters, the compounding effect of the fees will result in net annual performance of 7.81%. Performance presented prior to June 1, 2009 was generated while affiliated with a prior firm. The investment decision-making process has remained intact and has been applied consistently since inception. The calculation methodologies have been consistent over time. No leverage, derivatives, or shorts are used. Past performance is not indicative of future results. A copy of the verification letter is available upon request.

There can be no assurance that the purchase of the securities in this portfolio will be profitable, either individually or in the aggregate, or that such purchases will be more  profitable than alternative investments. Investment in any JFG Global Tactical Portfolio, or any other investment or investment strategy involves risk, including the loss of
principal; and there is no guarantee that investment in JFG’s Portfolios, or any other investment strategy will be profitable for a client’s or prospective client’s portfolio. Investments in JFG’s Portfolios, or any other investment or investment strategy, are not deposits of a bank, savings and loan or credit union; are not issued by, guaranteed by, or obligations of a bank, savings and loan, or credit union; and are not insured or guaranteed by the FDIC, SIPC, NCUSIF or any other agency. The composite strategy provides diversified exposure to various asset classes such as equities, fixed income, and alternatives utilizing liquid exchange traded products. The Blended Benchmark Growth is a benchmark comprised of 65% MSCI ACWI, 25% Citi World Government Bond Index, & 10% S&P GSCI, rebalanced monthly. The MSCI ACWI Index is a free float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The Citi Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment. The Blended Benchmark Growth returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly into an index. A more detailed description of the benchmark's constituents is available upon request.

The Blended Benchmark Moderate is a benchmark comprised of 50% MSCI ACWI, 40% Citi World Government Bond Index, & 10% S&P GSCI, rebalanced monthly. The MSCI ACWI Index is a free float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The Citi Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment. The Blended Benchmark Moderate returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly into an index. A more detailed description of the benchmarks constituents is available upon request.

The Blended Benchmark Conservative is a benchmark comprised of 35% MSCI ACWI, 55% Citi World Government Bond Index, & 10% S&P GSCI, rebalanced monthly. The MSCI ACWI Index is a free float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The Citi Government Bond Index (WGBI) measures the performance of fixed-rate, local currency, investment-grade sovereign bonds. The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment. The Blended Benchmark Moderate returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly into an index. A more detailed description of the benchmarks constituents is available upon request.

The Blended Benchmark Income is a benchmark comprised of 90% Barclay’s Global Aggregate Bond Index, & 10% MSCI ACWI, rebalanced monthly. The Barclays Global Aggregate Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. There are four regional aggregate benchmarks that largely comprise the Global Aggregate Index: the US Aggregate (USD300mn), the Pan-European Aggregate, the Asian-Pacific Aggregate, and the Canadian Aggregate Indices. The Global Aggregate Index also includes Eurodollar, Euro-Yen, and 144A Index-eligible securities, and debt from five local currency markets not tracked by the regional aggregate benchmarks (CLP, MXN, ZAR, ILS and TRY). A component of the Multiverse Index, the Global Aggregate Index was created in 2000, with index history backfilled to January 1, 1990. The MSCI ACWI Index is a free float adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. The Blended Benchmark Income returns do not include fees or expenses that are associated with managed accounts. You cannot invest directly into an index. A more detailed description of the benchmark's constituents is available upon request.

JFG is a New York based Registered Investment Advisor. JFG specializes in separately managed accounts, Collective Investment Funds for retirement accounts, private label funds for select Independent Registered Investment Advisors and sub-advised mutual funds.

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