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Markets In Motion - Self-Inflicted Wounds

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Macro Backdrop

Self-Inflicted Wounds

img-1Since the Reagan/Clinton era, United States Presidents haven’t influenced economic growth in a positive way; think of Bush II’s Iraq war fiasco and Obama’s stifling business regulations regime. Trump showed great promise with the first major US tax reform since 1986, only to stumble recently with anti-growth tariff and immigration policies. These are both a big deal: the US owes much growth and innovation leadership to immigration. And try to find any mainstream economists or traditional Republicans (the latter being an increasingly rare sighting) who support trade “wars” and anti-free trade policies. On trade deficits, standard economic theory says that capital will flow to regions and countries with relatively high interest rates. Countries with relatively high neutral rates like the US will tend to run structural current account deficits, whereas countries with relatively low neutral rates will tend to run surpluses. The failure of the Trump administration to understand this basic economic lesson could inflame the ongoing trade spat between the US and China, at a time when populism is on the rise, and China is challenging the US for global influence. GDP growth is far more correlated to immigration and free trade than to trade deficits. That the far left and far right in the US are united against this basic economic principle gives us more than a few concerns about the nature and timing of a global slowdown.

img-2We have made a few changes this month in our asset allocation.We have lowered exposure to US financials, as we believe a flat yield curve hurts short-term growth prospects and we have added to “value” equities in the US & Europe. If we are right that we are in the late innings of a credit expansion (a global slowdown appears to be likely within the next two years), then quality and relative price metrics will matter. Emerging market equities, Euro region equities, and Japanese equities are all attractively priced relative to most US equity sectors. We are watching the “trade war” rhetoric closely. That two-year window where we think equity and commodities will outperform fixed income feels a lot smaller after last week’s barrage of protectionist blather from the White House combined with anti-immigration rhetoric. Our base case is that the US Administration is posturing for the Trump voting base and the Bernie Sanders head-in-sand anti-growth constituencies ahead of the midterm elections, and will avoid suffocating growth with poor policy. If we are wrong, we will begin to trim our equity exposure as the second quarter unfolds ahead.

We are positioned in our Global Tactical portfolios to capture the upside of the later innings of a long-running global credit expansion. We are constantly looking for evidence that will cause us to reposition away from our more aggressive positions. Global Tactical Allocation is not just the ability to “go anywhere,” it’s being able to pivot when the facts change.

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  • img-4We have eliminated our tactical cash position in our GTC and GTA portfolios. Recent volatility has given us an opportunity to put cash to work in equities.
  • 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 continue to rise 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/factors: value, technology, energy, aerospace & defense. Lower valuation equities provide us with a defensive holding, which we feel is prudent in later stages of the US credit cycle. 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. Global energy market fundamentals have continued to improve, and we expect inflation to increase over the course of 2018. Global military spending will increase in coming years, as US hegemony fades and a multi-polar world emerges—the aerospace & defense industry will be a beneficiary.
  • We have exposure to both broad European and hedged-currency Eurozone equities. Following several important elections, the political environment in Europe is much less uncertain. This should enable further structural reforms which will support European assets. We have hedged some of our exposure to the Euro, as we expect it to weaken vs. the dollar.
  • We have exposure to both large- and small-cap Japanese equities. They 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 have not hedged any of our Yen exposure.
  • We have significant exposure to emerging market equities, which 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.
  • We hold a position in global agriculture equities. Increasing inflationary pressures and underweight investor positioning should support the industry in 2018.
  • We hold positions in broad commodities and gold. We expect inflation to rise in 2018, which will support commodity markets.

Recent GTA Portfolio Changes

  • The yield curve has flattened too severely in the US and is no longer supportive of the US financial sector, so we have exited our position.
  • As we enter the later stages of the US credit cycle, it is prudent to begin building a position in defensive US equities, so we have initiated a position in an ETF targeting companies with low valuations.
  • Technology firms have come under pressure recently, and we have used the opportunity to increase our exposure.
  • The political environment in Europe has continued to improve, so we have increased our allocation there.

GTA Portfolio Changes

img-5Since 12/31/20171

Profligate corporate borrowing has been a hallmark of the current credit cycle, particularly in the US where corporate leverage is quite extended. As a result, lower quality corporate credit may be among the first assets to come under pressure at the end of the current cycle. We have therefore reduced our exposure to US high yield credit.

We have owned US financials since August 2016, expecting the sector to benefit from rising US interest rates, and have been well-rewarded for the allocation. However, the yield curve has flattened too severely in the US to support the allocation, so we have exited the position.

In the two months following the German federal election in September, which yielded a disappointing result, we exited our two European equity positions. Reforms to promote growth and stability in Europe are more difficult to achieve without a strong German government, and European equities lagged the rest of the world in the months after. Following the agreement between Angela Merkel’s CDU and the center-left SPD parties to form a coalition government, as well as an acceptable result to March’s Italian election, we have initiated two positions in European equities. We hold a position in broad European equities and a position in currency-hedged Eurozone equities. This gives us broad exposure to Europe, which hedges our exposure to the Euro, which we expect to weaken against the dollar.

Strong economic growth and reduced slack in the global economy may propel inflation higher in 2018. We have therefore increased our exposure to assets that benefit from higher inflation. Positions in gold, broad commodities, global agriculture equities, and the US energy sector all help protect the portfolio from a rising inflation environment.

Please do not hesitate to contact us with any questions!

Best regards,

John A. Forlines III

Chief Investment Officer
Investment Committee Member

W.E. Donoghue Team

Global Tactical Allocation Strategies
Investment Management


1Information as of 4/11/2018. Individual account allocations may differ slightly from model allocations.
2Some Emerging Markets allocation overlaps with regional allocations.
3Excludes GTA’s 15% alternative, and cash, and cash equivalent positions.
4Contains international exposure
5Gross of Fees

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 Markets in Motion are based on data calculated by W.E. Donoghue & Co., LLC (W.E. Donoghue) 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 W.E. Donoghue’s Form ADV Part 2A and Client Service Agreement, all of which should be requested and carefully reviewed prior to investing.

The Global Tactical Allocation Composite (“Composite”) was created on July 1, 2009. The Global Tactical Conservative Composite (“Composite”) was created on February 1, 2014. The Global Tactical Income Composite (“Composite”) was created on February 1, 2014. The Global Tactical Growth Composite (“Composite”) was created on February 1, 2015. W.E. Donoghue acquired 100% of the assets of JFG on December 29, 2017.

Composite returns are calculated gross of investment management fees, net of investment trading expenses and underlying fund costs but do 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, which are described in greater detail in the firm’s Form ADV Part 2A, 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%. No leverage, derivatives, or shorts are used. Past performance is not indicative of future results.

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 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 W.E. Donoghue’s Portfolios or any other investment strategy will be profitable for a client’s or prospective client’s portfolio. Investments in W.E. Donoghue’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. Diversification does not guarantee a profit or protect against a loss.

The Blended Benchmark Growth is a benchmark comprised of 65% MSCI ACWI, 25% Citi World Government Bond Index, and 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, and 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 benchmark’s constituents is available upon request.

The Blended Benchmark Conservative is a benchmark comprised of 35% MSCI ACWI, 55% Citi World Government Bond Index, and 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 benchmark’s constituents is available upon request.

The Blended Benchmark Income is a benchmark comprised of 90% Bloomberg Barclays Global Aggregate Bond Index, and 10% MSCI ACWI, rebalanced monthly. The Bloomberg 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.

The information contained in this presentation related to JAForlines represents the strategies and performance achieved prior to the acquisition. W.E. Donoghue & Co., LLC is a registered investment advisor with the United States Securities and Exchange Commission in accordance with the Investment Advisors Act of 1940.

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