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Markets in Motion - The Next Long Night is a Long March

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Markets in Motion - The Next Long Night is a Long March

It’s hard to keep up with all the kings and would-be kings in the monumental HBO series Game of Thrones. Not so much in modern times, where there are only two combatants for the “Global Iron Throne”—the United States and China. These are the two superpowers who not only emerged from the rubble of the most recent Long Night, the Great Recession and liquidity crisis of 2007–2008, but have grown stronger, in all facets of economic, political, technological, and military power. And while the two main pillars of the decade-long bull market for equities—accommodative monetary policy and slow but steady growth in corporate earnings—are still in place today, the landscape ahead will be dominated by the US and China’s actions, reactions, and conflicts.

2019-05-chart-1Here are the key takeaways:

  1. While the US is in the lead, short-term pressures like tariffs will not impinge Chinese growth but will hurt US consumers and corporations

    Even though US business leaders support the technology and intellectual property reforms the US is asking for, almost none support tariffs. They know that the Administration’s tactics will cause tremendous pain in some quarters. Farmers in the Midwest, hit by falling crop sales to China, are in deep trouble. Moreover, business leaders are extremely concerned by the logistical headaches associated with President Trump’s threats to raise levies on $200 billion worth of Chinese goods from 10% to 25%. That move would raise average overall US tariff levels to 7.5%, higher than many emerging markets. Peter Robinson, chief executive of the US Council for Foreign Business (the group’s Directors include executives at Chevron, Pfizer, Microsoft, Citigroup, General Mills and Dow Chemical) stated this week that, “When the US and China fight, nobody wins, as the commodity and stock markets have made clear.”

  2. The US is fighting an 18 month to 4-year war, China is engaged in a 30- to 50-year conflict

    The current US reaction is centered on China’s “long march” to power, and despite the US’ lead in almost every global leadership category, China is clearly approaching parity:
    2019-05-chart-2China’s centrally planned economy means resources are allocated in lockstep—think about the massive “One Belt, One Road” infrastructure project over the last five years, where the politically polarized US has been inactive. Another salient fact: China isn’t nearly as dependent on US markets as commonly thought— Chinese exports to the U.S. account for only 3.6% of GDP, down from 7.3% of GDP in 2006. Moreover, the US’ withdrawal from the Trans-Pacific trade partnership means China is free to exploit the fastest region of global growth without US influence. And there is more uncertainty on the way: we have seen that markets are roiled by US tariff policy now. Is there a point at which China might lash out against America, even at a cost to itself? Looking at the current trade deficit provides a clue. The bulk of the $380 billion trade deficit consists of commodity-type imbalances, like steel and other building materials which have lowered costs for US-based businesses and consumers. But American businesses, from Apple to General Motors, have big footprints in China. American firms made roughly $250 billion more in sales in China in 2018 than Chinese firms did in America. The Chinese government could begin consumer boycotts, hold up supplies at customs and inundate factories with safety inspections. Sometimes the obvious needs to be restated: in the hyper-connected world we live in, where US S&P 500 companies derive over 40% of revenues from foreign sales, no one “wins” a trade war.

  3. Expect and plan for volatility and opportunity in markets through 2020

    There will still be large pockets of opportunity in global markets given favorable monetary conditions rates and gradual growth; our approach is to emphasize diversification and spend a lot of time researching the effect of currency, rates, and economic conditions on regions and sectors. Portfolio construction that manages risk over the long haul is a sensible strategy as the long summer of risk bull markets starts to come to a close. No one can predict the exact timing of the next a global recession. But, “Winter is Coming,” and our job is to protect Advisors and their Clients with our arsenal of research, investment products, and service.

2019-05-chart-3

Recent Portfolio Changes

  • We exited our position in US Industrials. We still believe that the final blow-off of this long bull market will be a cyclically fueled race to the finish. This month, we look to remove a little of the cyclical volatility and keep our level of equity risk slightly below neutral. We removed our overweight stance to Industrials.
  • We initiated a position in Global Minimum Volatility. Short-term, we are cutting some cyclical exposure and adding some global, low volatility blue chips, which we think makes a lot of sense if there is a snap back in the market.
  • We trimmed Ultra Short-Term Duration exposure to slightly add to risk assets.
  • We initiated a position in Gold. We are also adding a short-term hedge to the portfolios in the form of gold. Given how Gold reacted during the last spike down, we believe it will add value to the portfolio.

Portfolio Changes
Since February 6, 20191

Fixed Income (US)

We continued to be overweight in our position to Ultrashort Maturity Bond. After a ~17% bounce for ACWI, the index is at strong resistance levels and has yet to break out of a sideways trend from 2018. It moved from “extreme” oversold conditions to overbought very quickly. Huge moves in interest rates have left government bonds at extreme overbought levels – reflecting a very bearish view of economic growth. High levels are warranted

We trimmed but retained our positions in Preferred Stocks. We remain convicted in our position, and believe they have a positive tailwind in place, but trimming risk at overbought levels is prudent.

Continue to avoid long duration fixed income in our portfolios: We favor ultrashort duration at the expense of allocations to longdated fixed income. Interest rates will continue to move higher leading to uninspiring total returns to duration.

Fixed Income (International)
We maintain our positions in Emerging Market Bonds. We continue to maintain Emerging Market Bonds – it’s attractive yield and the current tailwinds for emerging markets will continue to provide the diversification benefits to the portfolio but trimming risk at overbought levels is prudent.

Equity (US)
We exited our positions in Healthcare and maintain a position in Quality Factor equities. We continued to consolidate exposure in our US equity book. 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.

Equity (International)
We maintain 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 trade war with China could have on Asia.

We maintain a position in Developed Market Equities (ex-US). We removed a defensive sector tilt from earlier in the year and added exposure to our International equity allocations. Our portfolio remains underweight Eurozone equities.

Alternatives
We maintain a position in Energy MLPs. We are concentrating our alternative exposure around our convicted view in Energy MLPs. The oil rout that began in October appears
to have run its course. 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.


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Please do not hesitate to contact us with any questions!
Best regards,

John A. Forlines III

Chief Investment Officer

Robert Shea

Co-Chief Investment Officer


1Information as of 5/13/2019. 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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