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Markets In Motion - On the Beach for Summer?

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Markets In Motion - On the Beach for Summer?

On the Beach for the Summer?

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The tradewinds have turned into headwinds in many of our risk markets. Even with the backdrop of solid global liquidity and low real rates, global growth is slowing, and the driver of that growth is shifting back towards the United States. As we noted last month’s Markets in Motion, Trade Winds and Tailwinds, trade wars represent an ominous and immediate threat to risk assets. Meanwhile, many of the monetary policy support that investors have relied on have begun to ebb in influence. This is not the end of the great credit expansion era that began in 2009; we are merely taking some risk off the table at this juncture and believe we will have better entry points at a later point.

2018-07-chart-1Let’s review the ebbing policy supports. First, a tight labor market and inflation in the US have kept the Fed in rate hike mode, and it no longer seems focused on the fear of falling asset prices or slowing global growth. Second, the ECB has clearly signaled there’s no “Greek-style” bailout for Italy. If you combine this with the BREXIT turmoil and Germany’s new political headaches, there are no short-term upside catalysts for Euro equity exposure. Finally, China’s gearing up for an unnecessary trade war with the US and coincidental currency devaluation has begun to further erode confidence. This is no more evident than in Japan, which surprised almost everyone with bad GDP print recently.

There are plenty of ways to get growth back on track, starting with an improvement in trade rhetoric, an implementation of a “softer” Brexit and for the Fed to slow the pace of rate increases. These political/fiscal/monetary fixes are all in doubt right now, and we have made adjustments in our Global Tactical portfolios to mitigate risk until we see calmer seas.

2018-07-chart-2We made three changes this month in our asset allocation. First, we eliminated EU & Japan equity positions. It’s a big move, but economic slowdowns are a big deal this late in the Credit Cycle, so we want to see some turnaround or far better prices to re-enter. We continue to own Value equities in the US and greater Asia ex-Japan, and we added Medical Device exposure to our US holdings. It’s a pure demographic play that we believe has both growth and value factors built in. Finally, we consolidated our commodity exposure to continue favoring oil and gold over other alternatives. We have ramped up our “summer turmoil” watch considerably—as we now hold 22% in cash and near cash equivalents in GTA. This is both a repositioning and a defensive posture; we are looking for better entry points in some sectors and regions as well as the catalyst mentioned above.

We believe that our factor, sector and regional exposure in the Global Tactical portfolios will allow us to capture the upside of the later innings of a long-running global credit expansion, but our current allocation posture is cautious.

Portfolio Positioning

2018-07-chart-3

2018-07-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 four US equity sectors/factors: Value, Technology, Energy, Medical Devices. Lower valuation equities provide us with a defensive holding, which we feel is prudent in the 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. Aging demographics and strong corporate balance sheets in the healthcare sector should provide tailwinds for medical devices.
  • 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 positions in broad commodities and gold. We expect inflation to rise in 2018, which will support commodity markets.

2018-07-chart-5GTA Portfolio Changes

Since March 31, 20181

We exited our position in US Financials. We owned US financials since August 2016, expecting the sector to benefit from rising US interest rates, and were well-rewarded for the allocation. However, the yield curve flattened too severely in the US to continue to allocate to the position.

We initiated a position in an ETF targeting companies with low valuations. As we enter the later stages of the US credit cycle, it believed it prudent to build a position in defensive US equities.

We exited 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.

Recent Portfolio Changes

This month, we exited our positions in Europe and Japan. It is a big move, but as we mentioned earlier, economic slowdowns are a big deal this late in the cycle. The ECB signaling on Italy, the BREXIT turmoil, and Germany’s new political headaches, have all led us to believe there are no short-term upside catalysts for Euro equity exposure. Japan’s negative GDP print in the first quarter has led us to be cautious.

We consolidated our commodity exposure to continue to favor Oil and Gold. The supply backdrop is more favorable for oil than for industrial metals. While the prospect of higher inflation is good news for gold in the long haul.

We initiated a position in US Medical Devices. We believe this has both growth and value factors built in due to US demographics and aging population.

We raised a significant cash position. We have ramped up our “summer turmoil” watch considerably. We believe there will be better points of entry into some sectors and regions, so we are using this increase as both a repositioning and a defensive posture.

 


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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 6/8/2018. 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

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 a 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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