New York, January 20th, 2016, Markets in Motion™

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New York, January 20th, 2016, Markets in Motion™

Macro Backdrop:

Most investment managers were happy to turn the page on 2015. It was a very difficult year: rampant deflationary forces broke important long-standing relationships, causing many investment strategies to go awry. Thankfully our fundamental credit-driven strategy helped our Global Macro Portfolios avoid these pitfalls, and our flagship Global Tactical Allocation portfolio finished 2015 up +1.20% for the year.

The first couple weeks of 2016 have not brought the relief that these weary managers were hoping for. Commodity and emerging market turmoil have spilled into developed market equities, with the S&P 500 down -7.9% and the MSCI ACWI down -9.2% YTD through market close on Friday 1/15. Our portfolios have done well to avoid much of this drawdown, with our most conservative allocations since the depths of the European debt crisis in 2012.

Current market volatility is very similar to what was experienced in August. Once again, the major catalyst for a selloff is the perceived increasing weakness in the Chinese economy. The People’s Bank of China has allowed the Chinese Yuan to weaken against the US dollar, which markets have interpreted as an admission of greater economic weakness than was previously assumed. Global risk markets have sold off sharply as a result, with commodities hit especially hard—oil is down -24% YTD. We view a weaker Yuan as a necessary part of China’s economic rebalancing—a process that will take years to accomplish. As the below chart shows, on a trade-weighted basis, the Yuan has been one of the strongest currencies in the world in recent years, and it should come as no surprise that Chinese policymakers would like to see it weaker.

The second half of the equation that has driven market volatility is the recent policy mistake made by the Federal Reserve. Increasing global deflationary forces, driven largely by a soaring US dollar, should have caused the Fed to postpone its cycle of raising interest rates. Instead, FOMC members feared they would lose credibility, and therefore their ability to use forward guidance to effect monetary policy, if they aborted their much-anticipated cycle of interest rate hikes. However, we fear that they may not be able to raise rates further, or worse have to reverse course and cut rates, which would do much greater damage to their creditability.

As a result of these twin factors driving global deflationary headwinds, asset allocators must be very selective in the risks that they take. We began preparing our portfolios for increased market volatility in June 2015, and they have weathered this storm well.

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 51% dollar denominated fixed income, 13% US equities, 23% international equities, 5% alternatives, and 8% cash and equivalents. We favor developed international equities and are avoiding emerging market equities and commodities. We have a tactical cash position to manage current market volatility.

Our fixed income exposure is limited to dollar denominated securities. We hold positions in long-duration US treasuries, investment grade corporate bonds, high yield bonds, preferred stock, and dollar denominated emerging market debt, which outperformed local currency debt by 12.2% in 2015. This gives us broad exposure to fixed income while avoiding foreign currencies and targeting the long end of the curve. We have increased our high yield allocation to take advantage of recent weakness.

Our US equity exposure is limited to low volatility equities, giving us broad exposure to US equities while minimizing drawdown risk by focusing on conservative sectors and companies. This increases our relative exposure to non-cyclical sectors such as consumer staples, healthcare, and utilities, and has served us well—outperforming the S&P 500 by 5.6% since we added the position in November.

We expect markets to begin to price in more dovish Federal Reserve policy than was previously expected. As a result, the dollar may weaken somewhat against the euro. However, European equities represent better value than US equities, and we continue to favor them. We have therefore decreased our currency-hedged European equity exposure, but maintained our unhedged exposure.

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

We hold a position in mortgage REITs. We expect that the Fed will not be able to increase short-term interest rates to the extent that markets anticipate, which will ease funding conditions for mortgage REITs and support earnings.

We continue to avoid commodities, which finished 2015 down -32.9% and are down -12.4% in 2016. Our portfolios have benefited greatly by avoiding commodities throughout this period and minimizing exposure to commodity producers through careful country and sector selection.

*Emerging Markets allocation overlaps with regional allocations

^Excluding GTA’s 59% fixed income, alternative, and cash positions

**Individual account allocations may differ slightly from model allocations.

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.