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Markets In Motion - The Right Port in the Storm

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Markets In Motion - The Right Port in the Storm

Macro Backdrop

The Right Port in the Storm

Humans are born with only two fears: the fear of falling and loud noises. It’s the latter one I’m thinking about when you see the “doom & gloom” being peddled to the investor victims who watch financial TV. Last week, a video of a veteran money manager proclaiming an imminent 30% equity markets crash found its way into one of our email boxes. It was loud because it originated on CNBC, a network devoted to serving up hearty portions of fear and greed to the investing public. The backdrop was a 3.25% swing over a 24-hour period in the S&P 500, the main US equity market. Looking at investor sentiment, it created the image of loose cannon balls on the deck of a tossing ship in rough seas. In our recent Spotlight on the Process entitled “Volatility is Back, and It’s Not a Bad Thing” we argued that storms and chaos in risk markets are healthy signs in times of global expansion; it’s when buyers and sellers are jousting for position. What is not normal or positive for risk markets is a year like 2017, where complacency and record low volatility reigned deceptively in becalmed market seas.

2018-05-chart-1The beauty of a “core” Global Tactical Allocation (GTA) approach is that we are free to the world’s seas (markets and asset classes) in pursuit of the real treasure: decent upside returns with the ability to go to port (cash) in storms. Right now, there are generational opportunities in global “value” equities, commodities and parts of the emerging markets debt/equity complex. A big part of the opportunity is fear-driven; fear of markets outside of the US, fear driven by headlines—an example we heard recently is “Argentina is the new Greece.” The fact that Argentina has a .71% share of projected 2018 GDP, roughly in line with the State of North Carolina, doesn’t faze the pundits and fear-mongers.

2018-05-chart-2We made two changes this month in our asset allocation. First, we lowered exposure to US equities and eliminated small cap Japan, but continue to own “value” equities in the US, Europe, Japan and greater Asia. If we are right that we are in the later 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. Raising cash to an overall 8% in GTA is more of a repositioning than a defensive measure; we are looking for better entry points in some of the sectors & regions we like. We continue to monitor fixed income exposure,by far the hardest of the three main asset classes. The US 10 year Treasury’s break over 3% is certainly significant, but so is dollar strength. If both US yields and the dollar remain strong, we may be forced to reign in some of EM exposure. We remain vigilant, but believe opportunities still outweigh pitfalls.

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.

2018-05-chart-3

2018-05-chart-4We have recently decreased our equity exposure in our portfolios in favor of a tactical cash position. While we remain constructive on equities, a better entry point may present itself in the near future.

  • We are avoiding foreign currency fixed income to benefit from higher US dollar interest rates. We expect spreads between the 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 three US equity sectors/factors: value, technology, energy. 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.
  • 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 large-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

  • We trimmed our tactical positions in US aerospace & defense and small-cap Japanese equities to consolidate our late cycle US thesis, as well as our relative valuation bias in Europe, Japan, and Emerging Markets versus the US.


GTA Portfolio Changes


Since 1/31/20181
2018-05-chart-5Profligate 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 5/7/2018. Individual account allocations may differ slightly from model allocations.
2Some Emerging Markets allocation overlaps with regional allocations.
3Excludes GTA’s 15% alternative, 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 in 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 in 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 in 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 in 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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