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Markets in Motion - Stay Allocated My Friend

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Markets in Motion - Stay Allocated My Friend

Given the current sweltering heatwave here in New York, we hope you will forgive us for conveying a very important message to our readers by paraphrasing an advertisement tag-line for a thirst-quenching beverage. Our central theme this month is “relax.” So many pundits are focusing on inverted yield curves, stocks telling us one thing…bonds another, whether Zion is the next Lebron (wait, that’s another conversation), that utter confusion reigns in Advisor and client land. Let’s cut through the humidity and misinformation and posit three simple and important points.

1. Major Bear Markets in Equities Almost Always Coincide with Recessions.

And we aren’t close to one—the slow, gradual global expansion that has produced little if any inflation over the last 10 years, will continue to grind on. Odds are also low for a recession in 2020, barring some huge shock such as a political crisis or an oil price spike triggered by war in the Middle East. Sudden surprises in individual US economic reports, like the apparent slump in GDP in the first quarter of 2019 to today’s much improved revisions, are ordinary occurrences and should not cause much concern unless they are supported by substantial amounts of other “financial conditions” type data. Right now, stocks are telling us that economic activity is robust and that paying for future growth is not expensive. Typically, in the 13-24 month period prior to a recession, returns tend to be substantially higher than during the rest of the expansion. We are approaching a “blow-off” phase, but global equities are currently trading at 15X forward earnings and, unlike last year, earnings estimates are conservative.

2. Inverted Yield Curves and Bond Data in General have Become Disconnected from Economic Activity.

2019-07-chart-1Bond market “signals”, such as yield curve inversion, no longer provide useful information about economic growth and by extension, stocks. First, the bond market’s signaling power has been weakened since the 2008 crash because of central bank intervention, regulatory pressure on banks, and liability-driven investors that hold bonds regardless of price or risk, like pension funds and insurers. Another contributor to the reason bond signals are failing to be reliable arbiters is due to the Federal Reserve’s reversal last December and their subsequent communications relative to their “new” measures of economic indicators. The Fed has decided that the linkages between inflation, unemployment and economic prospects (that used to be the main guides to monetary policy) are no longer valid, so bond yields are disconnected from economic growth. In that light, the stocks vs. bonds argument is silly, because low bond yields simply reflect the near certainty of very low short-term interest rates persisting into the next decade. That’s the “gradual” part of global expansion. Meanwhile, new highs on Wall Street and near-record prices for many European and Asian companies are justified if the world economy continues to expand in real terms by around 3.5%. With the bond market implying that central banks will, rightly or wrongly, keep interest rates near zero forever, it is perfectly reasonable and natural for equity markets to apply ever higher valuation multiples to the earnings that businesses can generate in conditions of decent real growth.

3. Invest with Global Allocation Managers that Understand Both Asset Classes.

Now that we have made the case that stocks and bonds are sending non-conflicting messages, we don’t want you to think that there’s no risk in either asset class. Indeed, we think there’s far more short-to-intermediate timeframe risk in longer duration bonds, and our House View is that short-term bonds provide far more value than long-term Treasuries or credit. We will need to be mindful of equity “bubbles” in regions and sectors over the next 18 months. But our job is to keep risk and returns in the front of our minds as we work for our Advisors and their clients, and we will continue to be vigilant. So, pour a cold one on us, and enjoy the rest of the summer.

With this month’s positioning, we increased our exposure to equities to bring our positioning to NEUTRAL, with an overweight in US equities and some re-positioning around the factor analysis above. We will have earnings season beginning in mid-July, so we will get more input on the risks discussed as well as the first look at forward 2020 earnings forecasts.

2019-07-chart-2

Recent Portfolio Changes

  • We exited our Global Minimum Volatility equities position in favor of pure beta Global equity exposure. Trade risks have abated on the margin after President Trump and President Xi’s meeting at G20 in Osaka. This shifts the focus back to the Federal Reserve. The current policy stance of the Fed (and other OECD Central banks) is supportive of continued economic expansion. Financial conditions have eased to the loosest levels since the mid-1990s. This favors risk-taking. So, we removed our hedge against short-term volatility and added exposure to broad global equities.
  • We trimmed Ultrashort Duration Bonds and initiated a position in European Financial equities. We added a cyclical and value position that will benefit from the re-acceleration of global growth and a steepening yield curve. Stocks remain cheap to bonds.

Portfolio Changes
Since April 1, 20191

Fixed Income (US)

We continued to be overweight in our position to Ultrashort Maturity Bond. Huge moves in interest rates have left government bonds at extreme overbought levels — reflecting a very bearish view of economic growth. We continue to see duration as a risk and favor ultrashort duration at the expense of allocations to long-dated fixed income. We’ve trimmed this position as bonds have become “cheap” relative to equities.

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: As we said earlier, we favor ultrashort duration at the expense of allocations to long-dated 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 — its attractive yield and the current tailwinds for emerging markets will continue to provide diversification benefits to the portfolio but trimming risk at overbought levels is prudent.

Equity (US)

We maintain positions in Quality and Momentum Factor equities and Exponential Technologies. We continued to consolidate exposure in our US equity book to focus on late-cycle factors and secular themes. 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. Over the shorter term, Momentum equities should outperform as economic growth re-accelerates in the second half of 2019 and trends persist. As a secular theme, 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.

Alternatives

We maintain a position in Energy MLPs. We are concentrating our alternative exposure around our convicted view in Energy MLPs. The asset class has an attractive yield and has held up well amid the most recent selloff in the barrel of oil. From here, spot oil prices are biased towards the upside, and global spare capacity is too thin to absorb/respond to a loss of all output from Venezuela and Iran simultaneously.


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

Co-Chief Investment Officer

Robert Shea

Co-Chief Investment Officer


1Information as of 7/2/2019. 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 Moderate is a benchmark comprised of 50% MSCI ACWI, 40% Bloomberg Barclays Global Aggregate, & 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 Barclays Global Aggregate measures the performance of global investment grade fixed-rate debt markets, including the U.S. Aggregate, the Pan-European Aggregate, the Asian-Pacific Aggregate, Global Treasury, Eurodollar, Euro-Yen, Canadian, and Investment Grade 144A index-eligible securities. 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 Blended Benchmark Conservative is a benchmark comprised of 35% MSCI ACWI, 55% Bloomberg Barclays Global Aggregate, & 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 Barclays Global Aggregate measures the performance of global investment grade fixed-rate debt markets, including the U.S. Aggregate, the Pan-European Aggregate, the Asian-Pacific Aggregate, Global Treasury, Eurodollar, Euro-Yen, Canadian, and Investment Grade 144A index-eligible securities. 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 Blended Benchmark Growth is a benchmark comprised of 65% MSCI ACWI, 25% Bloomberg Barclays Global Aggregate, & 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 Barclays Global Aggregate measures the performance of global investment grade fixed-rate debt markets, including the U.S. Aggregate, the Pan-European Aggregate, the Asian-Pacific Aggregate, Global Treasury, Eurodollar, Euro-Yen, Canadian, and Investment Grade 144A index-eligible securities. 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 Blended Benchmark Income is a benchmark comprised of 80% Barclay’s Global Aggregate Bond Index, 10% MSCI ACWI, & 10% S&P GSCI rebalanced monthly. The Barclays Global Aggregate measures the performance of global investment grade fixed-rate debt markets, including the U.S. Aggregate, the Pan-European Aggregate, the Asian-Pacific Aggregate, Global Treasury, Eurodollar, Euro-Yen, Canadian, and Investment Grade 144A index-eligible securities. 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 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 blended benchmark returns are calculated on a fully collateralized basis with full reinvestment. The 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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JAForlines has been acquired by and operates through W.E. Donoghue & Co., LLC.
W.E. Donoghue is a registered investment adviser with United States Securities and Exchange Commission in accordance with the Investment Advisers Act of 1940.

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