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Markets in Motion - Fear and Greed with a Twist

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Markets in Motion - Fear and Greed with a Twist

We have been rewarded for our constructive macro /no recession view, and for not succumbing to the retail-driven “sell everything” panic of late December. At the time of this writing, we have recouped the losses incurred during that very violent year-end sell-off. We are pairing risk in credit, equities and alternatives across all of our portfolios which is primarily a function of how quickly risk-assets have moved from historically oversold to overbought, the rapid snapback in US equity valuations, and in front of some potentially important macro events.

2019-02-chart-1Conditions and technical work inform us that we should be wary of chasing the S&P 500 above 16.5x forward P/E and MSCI ACWI above 13x. Short term, we acknowledge that this tape has a tendency to overshoot, thus 16.5x/13x wouldn’t be any crazier than what happened back in December (S&P 500 forward P/E collapsed to 13.5x).

In the US, questions remain weighted towards identifying downside catalysts (as opposed to focusing on the reasons why the S&P 500 should continue higher), suggesting the “pain trade” is still to the upside. However, while positioning, sentiment, and “FOMO” can all be powerful forces, the S&P 500 is getting to be overbought, and our Firm’s consensus is that we should get (at least) some consolidation. In ROW, and especially the EU, there are downside catalysts galore. BREXIT is no longer a “slow-motion train wreck”—and in the spirit of Oscars’ season, we should consider The Runaway Train, a 1986 Jon Voight vehicle that won 4 Academy nominations (including Voight for Best Actor). How did that one end? With apologies to IMDb: “Manny (Voight/Teresa May) uncouples his/her out-of-control lead engine. He/She waves goodbye, ignoring screaming pleas to shut down the lead engine, and climbs onto the roof of the lone engine in the freezing snow, arms stretched out, ready to meet the end. Cut to Manny's friends/Conservative MP’s mourning in their pints as the lone engine disappears into the storm.” Germany, the EU’s other main “engine,” is already slowing, so it is hard to see EU/UK as any more than a series of short window trading opportunities.

2019-02-chart-2Now for the Twist.. while the risk markets have gotten overbought in the intermediate-term, sentiment approaching giddy in the short-term, professional investors have SOLD this rally! $18b came out of equity ETF’s in January. The JPM Hedge Fund Long/Short ratio stands near the lowest level since February 2016, their defensive posture highlighting unease despite the very sharp rebound in markets. The big new addition to this bullish narrative (from a contrarian standpoint) is coming from the BAML (Bank of America Merrill Lynch) Fund Manager Survey, covering managers with > $500b in capital under management. The new FMS is showing the number of Asset Allocators who are “overweight cash” at it’s highest level since January 2009, and global equity allocation among surveyed fund managers down to its lowest level since September 2016.

This doesn’t mean the market has to go higher, but it does warn us that headline-driven shakeouts will present buying opportunities. We think it was prudent to further reduce risk into this rally, but we are working diligently on our buy list to pounce when the opportunity presents itself.

2019-02-chart-3

  • 2019-02-chart-4Increasing our exposure to Cash Equivalents: After a 15% bounce in the S&P 500, a move from “extreme” oversold conditions to overbought conditions, high cash levels are warranted.
  • Avoiding long duration fixed income in our portfolios: Interest rates may continue to rise as economic growth remains above trend, 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.
  • Trimming our exposure to US equity. We remain focused on three sectors/factors: Quality, Technology, Health Care: Quality equities possess pricing power, exhibit strong profitability, and have additional sustainable competitive advantages which allow businesses to remain viable over time. We feel this holding 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 health care sector should provide tailwinds for the industry – its defensive nature also acts as an important asset allocation tool.
  • 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.
  • Maintaining exposure to Developed Market (ex-US) equities: We consolidated our international equity exposure to remove a majority of our tilts and underweight positioning. Our two remaining tilts are moderately overweight emerging markets and underweight Eurozone equities.
  • Trimming our position in Energy MLPs. The oil rout that began in October appears to have run its course, and at this point, a regime failure in Venezuela is a high probability event - a production collapse would be positive for oil prices. This will be a tailwind for energy infrastructure.

GTA Portfolio Changes
Since November 30, 20181

We exited our position in US Small-Cap Value equities. We reduced our US equity exposure and moved into a more favorable sector.

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 are now overweight emerging market equities.

We exited our position in Small-Cap Japanese equities. Japan’s monetary policy remains loose, but its earnings outlook is murkier. Our Japanese equity stance is now neutral. We exited our position in Mortgage REITs. We maintain a position in Energy MLPs. We are concentrating our alternative exposure around our convicted view in Energy MLPs. Oil seems to have found a bottom, and at this point, a regime failure in Venezuela is a high probability event which poses immediate risks to global oil production – a positive for WTI & Brent prices and a tailwind for energy infrastructure.

We exited our positions in Medical Devices and Value, as well as trimmed our position in Technology. We initiated a position in Quality factor equities. We continued to consolidate exposure in our US equity book and moved to neutral positioning vs. the benchmark. Quality equities hold financially strong companies with solid balance sheets and stable earnings – which is prudent in the later stages of a credit cycle.

We exited our position in Global Consumer Staples and initiated a position in Developed Market Equities (ex-US). We removed a sector tilt and added exposure to our International equity allocations. Our portfolio remains underweight Eurozone equities.

We increased our position to cash equivalents. After a 10% bounce for the S&P 500 from “extreme” oversold conditions, high cash levels are warranted.

Recent Portfolio Changes

  • We trimmed our positions in Energy MLPs, Preferred Stocks and Health Care and Technology equities. We remain convicted in our positions, and all still have positive tailwinds in place, but trimming risk at overbought levels is prudent.
  • We continued to increase our position to cash equivalents. After a 15% bounce for the S&P 500, the index is at strong resistance levels and has yet to break its downtrend from September 2018. It moved from “extreme” oversold conditions (fear) to overbought (greed) very quickly. High cash levels are warranted.

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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 2/6/2019. Individual account allocations may differ slightly from model allocations.
2Some Emerging Markets allocation overlaps with regional allocations.
3Excludes GTA’s 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% FTSE 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 FTSE 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% FTSE 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 FTSE 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% FTSE 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 FTSE 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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