New York, November 17th, 2015, Markets in Motion™

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New York, November 17th, 2015, Markets in Motion™

Macro Backdrop:

Following a volatile August and September, global equity markets rallied sharply in October, with US equities regaining the bulk of their losses and the S&P 500 rising more than 13% from its low on September 29th to its high on November 3rd. This rally has stalled in the month of November, with global equity markets retracing some of their October gains.

The reversal of October’s rally has come as no surprise to us, and we took advantage of the brief euphoria to further reduce risk across our portfolios on November 6th. What was most telling about the nature of October’s rally was commodities’ complete lack of participation—the S&P Goldman Sachs Commodity Index finished October up only +0.23%. This demonstrates that global economic fundamentals have not improved materially, and that strong disinflationary forces still pervade global financial markets.

Additionally, as a result of improved US labor market conditions, the Fed has signaled that it is likely to raise the Fed Funds at its December FOMC meeting. Markets have taken note, and Fed Fund futures currently imply a 70% probability of a December rate hike, up from 26% in mid-October. While we think the exact timing of a single interest rate hike is not terribly important on its own, we do think there is a chance that the Fed will act too aggressively in the face of an increasingly deflationary external economic environment.

Inflation and inflation expectations are at levels not seen since 2009, and much of the declines since mid-2014 have been driven by a strengthening US dollar. Higher short-term rates would put additional upward pressure on the dollar, increasing disinflationary forces in the economy. Furthermore, both the European Central Bank and the Bank of Japan may increase their respective quantitative easing programs during the next year, and capital flows out of emerging markets will keep those currencies under pressure. Therefore the US dollar is not likely to depreciate meaningfully in the short- to intermediate-term, and several potential catalysts exist to drive further dollar strength. As a result of the rising likelihood of a “policy mistake” by the Fed, we have reduced risk in our portfolios for the 5th consecutive month.

GTA Portfolio Positioning:

Our equity positions are limited to developed market countries and our fixed income positions are limited to dollar denominated holdings. Overall, our GTA portfolio holds 46% dollar denominated fixed income, 10% US equities, 28% international equities, 5% alternatives, and 11% cash and equivalents. We favor developed international equities and are avoiding emerging market equities, hold a limited amount of foreign currency exposure, and have a small tactical cash position to manage current market volatility.

Our fixed income exposure is limited to dollar denominated securities. We hold positions in high yield bonds, preferred stock, long-duration US treasuries, and dollar denominated emerging market debt. This gives us broad exposure to fixed income while avoiding foreign currencies and targeting the long end of the curve.

We have recently extended the duration of our US treasury exposure and increased our exposure to preferred stock and emerging market bonds. This extends the overall duration of our fixed income holdings, and will enable our portfolios to benefit from a flattening of the yield curve, which we expect to happen if the Fed tightens policy in a disinflationary environment.

We continue to favor European and Japanese equities to US equities, which have outperformed YTD.

We have withdrawn our exposure to the US technology sector. Technology stocks have long been a staple of our portfolio and have outperformed broad US equities significantly in recent years. However, we felt that the risk of continued stock market volatility was great enough to warrant a rotation into lower beta exposure to US equities. We have therefore replaced our position in the technology sector with one in low volatility US equities.

We expect the ECB’s quantitative easing program to continue to drive European equity outperformance. Our European equity exposure is split evenly between hedged and unhedged with respect to the euro in order to minimize the impact of currency volatility. With Spanish general elections set to be held on December 20th, Spanish equity market volatility may increase. We have therefore replaced our position in Spanish equities with broad Eurozone equities while we await the results of the elections.

We have maintained our exposure to Japanese equities, which are supported by the Bank of Japan’s aggressive monetary policy. In order to minimize the impact of currency volatility, we have split our exposure between hedged and unhedged positions.

We have decreased our exposure to mortgage REITs for the second time this year. As short-term dollar interest rates have increased, mortgage REITs’ borrowing costs have increased which has eroded their profitability. This warranted reduced exposure in our portfolios.

*Emerging Markets allocation overlaps with regional allocations
^Excluding GTA’s 62% fixed income, alternative, and cash positions

JFG Team
JAForlines, LLC
Investment Management

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.

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The views expressed are current as of the date of publication and are subject to change without notice. There can be no assurance that markets, sectors or regions will perform as expected. These views are not intended as investment, legal or tax advice. Investment advice should be customized to individual investors objectives and circumstances. Legal and tax advice should be sought from qualified attorneys and tax advisers as appropriate.