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Markets in Motion - Home for the Holidays

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Markets in Motion - Home for the Holidays

Home for the Holidays

As we approach the end of 2018, we want to spend our final issue of this year looking towards the positives. Everyone has been hearing (and reading) all the bad market news all over the globe. We’ve all experienced enough of that, and in January we’ll be making a full accounting. 2018 has been especially hard on asset allocators, with many correlations falling painfully out of sync—equities, bonds, commodities that often traded up or down in lockstep fell out of step. We turned more conservative in October, yet our strategies still had a hard time seeing good results that weren’t in the cash or nearcash bucket.

2018-12-chart-1No, this is a time of the year to look for signs of good cheer, and despite the frothy negative rhetoric among the pundits, let’s consider these points from our research as we look to next year:

  • Global growth looks to remain above trend in 2019, so we aren’t headed to an imminent recession
  • Leverage, Risk and Credit conditions are still benign, although there are increasing signs that the US Federal Reserve has prematurely stifled credit creation with the massive roll-off of its Quantitative Easing (QE) super-sized balance sheet
  • Most economies, especially the US, still have a combination of absolute low rates and fiscal stimulus in place
  • Finally, sentiment is at 2008 lows; without a recession on the immediate horizon, this is about as risk-bullish a sign you could ask for in equity-related markets and has proven so in the past (see chart above)

We want to leave you with an image from a country with every reason to be deeply depressed this holiday season—the United Kingdom—where BREXIT politics have taken a huge bite out of growth and sentiment. The truth is, hardly anyplace I’ve traveled over the years lights up for Christmas better than London. Every turn of the corner, every small square, virtually every commercial establishment is ablaze with lights (this scene is from Convent Garden). These year-end holidays are the time to turn to family and friends and enjoy the company we keep and cherish.

2018-12-img-2We are grateful for the Advisors, firms, and their clients who do business with us, and we resolve to keep working hard on their behalf.

This month, we reduced our equity exposure in favor of cash equivalents and alternatives. While we remain optimistic about late cycle equity returns, our tactical outlook shows noise and volatility in the shorter-term. Therefore, de-risking this month was prudent. We exited our positions in Small-Cap Value and Small-Cap Japan equities. We consolidated our US exposure, and Small-Cap Value was less favorable. Even though Japan’s monetary policy remains loose, it’s future earnings outlook is now poor. We initiated a position in Energy MLPs. Oil seems to have found a bottom, which will be a tailwind for energy infrastructure.2018-12-chart-3

  • 2018-12-chart-4Avoiding foreign currency fixed income: By avoiding foreign currency fixed income, we hope to benefit from higher US dollar interest rates. Like previous months, we continue to expect spreads between the US dollar and foreign currency interest rates to narrow, and therefore we believe we will profit by concentrating all our fixed income exposure in US dollar-denominated holdings.
  • 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. Thus, we continue to avoid long duration fixed income in our portfolios.
  • Maintaining exposure to four US equity sectors/factors: Value, Technology, Healthcare & Medical Devices: Our view remains consistent with the previous months as we continue to see lower valuation equities providing 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. Aging demographics and strong corporate balance sheets in the healthcare sector should provide tailwinds for medical devices.
  • Maintaining exposure to Emerging Market Equities: The fundamental picture remains strong and the most important risk to emerging markets—a big Chinese growth slowdown or collapse in its currency—is unlikely. We continue to believe that these risks are now mainly contained, or largely priced in which should bode well for equity markets.
  • Supporting exposure to Global Consumer Staples equities: With tight labor markets bolstering consumer confidence and decent valuations, we believe an overweight position to consumer staples is warranted. The aging bull market is vulnerable to downside risk which should favor this classically defensive sector.
  • Maintaining a position in Mortgage REITs. In the absence of a commodity boom, we want to get paid cash dividends for any remaining inflation hedges. Our two major alternative positions are both high yielding.
  • Initiating a position to Energy MLPs. Oil seems to have found a bottom, which will be a tailwind for energy infrastructure.

GTA Portfolio Changes
Since September 30, 20181

We initiated a position in Global Consumer Staples Equities. Tight labor markets bolster consumer confidence, which combined with decent valuations, present a nice entry point for consumer staples. The classically defensive sector serves as another tool in our tactical positioning.

We exited our position in Broad Commodities. We eliminated this hedge. We see Fed tightening adding a headwind for precious metals, a slowdown in Chinese growth and
environmental reforms limiting Industrial metals upside, and agriculture markets remaining well supplied through 2018, outstripping demand.

We increased our position in Cash Equivalents. We favor cash yields at the expense of allocations to long-dated fixed income. Interest rates will continue to move higher leading to uninspiring total returns to duration.

We added to our position in Emerging Market equities. The most important risk to emerging markets—a big Chinese growth slowdown or collapse in its currency—is unlikely. We are still watching the effects the tariff and trade wars with China could have on Asia, but our overall outlook is a little more positive, and we believe that these risks are now mainly contained, or largely priced in which should bode well for equity markets.

We lowered our allocation to fixed income – exiting our positions in 7-10 Year Treasuries and High Yield Bonds. We entered 7-10 Year Treasuries to take advantage of a countertrend rally, in an otherwise cyclical bear market for bonds, given oversold, lop-sided technical conditions and bearish sentiment. That has played out, and we continue to
believe government bond yields will grind higher. High Yield has been an important allocation during the current economic expansion. But with tight credit spreads and potential default risk rising, the asset class no longer offers an attractive risk premium.

Recent Portfolio Changes

  • We exited our position in US Small-Cap Value equities and added to US Healthcare. We reduced our US equity exposure and consolidated into a more favorable sector.
  • We exited our position in Small-Cap Japanese equities. Japan’s monetary policy remains loose, but its earnings outlook is now poor.
  • We initiated a position in Energy MLPs. Oil seems to have found a bottom, which will be a tailwind for energy infrastructure.
  • We continued to increase our position to cash equivalents. With recent market volatility and unattractive prospects for duration, continuing to de-risk our portfolio with cash equivalents is prudent.

If you are a financial advisor and want to see the full version, request access to our Advisor Resources section.

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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 12/18/2018. 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 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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