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Markets In Motion - December 2017

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Macro Backdrop

2017 has been an outstanding year for our Global Tactical Portfolios. All four have registered substantial outperformance against their benchmarks and peer groups, with our flagship Global Tactical Allocation portfolio returning +16.98% YTD5 through 11/30/2017 versus its blended benchmark’s +13.85%.

One of the hallmarks of the macro environment in 2017 was the calm that presided over most markets, enabling us to focus on more minor trends and events. We were cautious in our exposure to long-duration fixed income, rewarded for our careful US sector selection, and we capitalized on international equity outperformance.

Following the 2016 US elections, US dollar interest rates rose sharply. Responding to this move, we shifted our fixed income allocation to 100% US dollar denominated securities in order to take advantage of the more favorable interest rate environment. We argued that the spreads between US dollar rates and many major international peers were at or near all-time highs, and therefore were more likely to converge than continue to diverge. This enabled us to earn higher yields in relative safety.

US equity sector selection was a major source of attribution. Our core positions—technology, financials, biotech, and aerospace & defense—delivered impressive returns, and our adjustments were well-timed. We exited our positions in small-cap and regional banks early in the year when the “Trump reflation rally” was losing steam, we initiated a position in the energy sector in late June, avoiding the first-half selloff, and made a timely exit from our biotech position in October.

We were also rewarded for our international equity exposure. After avoiding emerging market equities for years, we added significant exposure and participated in their recovery. For most of the year, we held large positions in European equities, which were supported by prospects for deeper European integration. However, a disappointing result to the German election in September diminished those prospects, and we exited our European positions entirely. At the same time, we increased our exposure to Japanese equities, which we believe are at the beginning of major move higher.

Some Advisors were surprised that we were able to produce strong outperformance in a year that lacked any major “macro events.” While protection against such events is one of the primary goals of our portfolios, they are designed to be able to outperform in all markets. A stable macro environment allows us to focus on our duration, sector, and country exposures—it enables us to enter and exit positions at our own choosing, instead of being dictated to by larger events and factors. Our goal is to deliver a happy holiday season to our Advisors and clients every year!

  • We 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 2018 as economic growth remains strong, inflation reemerges, 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. Strong economic growth will support global energy markets, and inflation may reemerge in 2018, which will support the energy sector. 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’ underweight exposure. We hold positions in both large- and small-cap equities, and have not hedged any of our Yen exposure.
  • 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 increased our exposure to the US energy sector. The US economy is now producing above its potential (leading to a negative output gap), and unemployment is below its long-term equilibrium, which together make the reemergence of inflation more likely in 2018. The US energy sector should be a beneficiary.
  • We have decreased our exposure to emerging market equities by eliminating our position in Chinese technology from our lower-risk portfolios. Chinese technology firms have performed extremely well this year, benefitting our Global Tactical Growth portfolio which added the portfolio in June. We later added the position to our Global Tactical Allocation and Global Tactical Conservative portfolios, but recent volatility has made the position inappropriate for investors with lower risk tolerances. We have therefore liquidated the position in those portfolios.

GTA Portfolio Changes Since 8/31/2017

2017-08-17-chart-3Eliminated European equity exposure.

  • The German federal election held in September yielded a very disappointing result for the prospect of deeper European integration, which had been a driving force behind the rally in European equities and the euro. Unfortunately support for the two major parties fell by a combined 14%, leaving a chaotic political environment for Chancellor Merkel to navigate. To date, a government still has not been formed, and the possibility of new elections has not been ruled out.
  • In addition, the upcoming Italian general election in May has the potential to be very disruptive. Italy has by far the lowest support for the EU of any EU country, with only 39% of respondents agreeing that their country has benefited as a member of the EU according to a 2017 poll by the European Parliament. Additionally, the leftist anti-Europe 5 Star Movement party currently leads in the polls, with the far-right Lega Nord not far behind in third. While it remains unlikely that we’ll see an “Italeave” scenario in the near-term, greater uncertainty is not what Europe needs right now.

Increased Japanese equity allocation and unhedged Yen exposure. After an incredible 14 years of contraction, the Japanese private sector is finally growing again, propelling strong corporate profit growth. Private sector growth should also support the Yen, which is deeply undervalued in real terms.


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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