Nauset Wealth Managment
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Category: Economic Development

Post-election Views or Much Ado About…

Well, we can’t say nothing. We aren’t going to rehash the election surprise. What we will do is share our views on the post-election market behavior, outline a possible scenario and actions we are considering and what we will be watching for over the coming months and years.

What happened? Virtually no one in the financial world predicted a rally immediately following a Trump victory, which also very few people predicted. For the record, the S&P 500 opened the day after the election, November 8, at 2130 and closed at 2182 on November 16. This equates to a +2.4% rally that leaves us just below the all-time market highs hit this past August. Now the underlying story is a bit different. During this same 8-day period financial stocks, particularly banks, rallied over +10% and some individual stocks by close to +20%, but many tech companies like Amazon fell by -3% or more. Healthcare and bio tech have also experienced a nice bump up. Bond prices have been knocked down driving yields on the 10-year Treasury bond from 1.88% to 2.35%; right at the 1-year high.

It’s important to note that other than bank stocks making a very decisive move up, none of these numbers are, in and of themselves, eye-catching from an absolute perspective. We have seen most of them in the past 12 months.

What do we see driving this behavior?  Right now we surmise the biggest driver is speculation on the third derivative of policy expectations. It is clearly not investing based on observed facts. Many market participants have made big rotations based on policies President-elect Trump hasn’t made clear, haven’t been implemented and whose effects are just hypotheses, i.e., speculation on the third derivative. Here is a summary of the big themes:

  1. Bank regulations get relaxed or go away so banks are more profitable
  2. Obamacare gets changed or eliminated and capping drug prices is not on the agenda, helping health care and biotech companies
  3. Fiscal stimulus, primarily through infrastructure spending goes up, international trade gets choked off, taxes are lower, all driving inflation and interest rates which helps banks and generally hurts bonds.

Now we don’t argue that these sound directionally right. However, the market movement was quick and in some areas sharp. Quick and sharp are not words often associated with governmental change and therefore we believe the market has over-reacted.

What do we hypothesize will happen over the next 12 months?  Here is a working, third derivative hypothesis, roughly in order of our conviction. It is not precise as we are using the third derivative —  think compass orientation not laser targeting.

  1. We get fiscal stimulus and lower taxes
  2. Rates and inflation rise, but not dramatically
  3. Bank regulations get tweaked not thrown out
  4. The economy improves a bit.
  5. Obamacare gets changed. What’s the effect? See the third derivative, i.e., who knows?

So what are we doing?  We have not been making major investment decisions. As investors, not speculators, we don’t react to quick market moves driven by assumptions from third derivative hypotheses. We are spending a lot of time looking at how we implement our existing overweight positions to technology, healthcare and biotech. We are also looking at financials as a possible overweight. We have been selectively adding to real asset positions due to higher expected inflation and what we believe has been undo pressure on REITs and our infrastructure positions. We have been selectively selling out of some fixed income positions.

What will we be watching? We will be watching measures of economic activity that might indicate a coming recession because we haven’t had one in over 7 years. We will be looking for dislocations in the market to add/rebalance to core positions. We will be listening and looking for real policy statements and activity that give us a better idea as to how those policies will eventually be implemented. We are particularly intrigued to see what happens to US Treasury rates as they will be a good indicator of how the world judges the relative safety of our markets versus all others.

In dealing with the next few years, it will be best to embrace Confucius’ blessing (curse?): “May you live in interesting times,” and to maintain a diversified and carefully monitored portfolio. 

Proceed With Caution.

Major US and global stock and bond indices ended 2015 flat or negative for the year despite a solid recovery in the fourth quarter. With a lackluster December and volatile start to 2016, investors remain concerned about growth, central bank policy and energy prices in the US and the rest of the world.

Our 2016 Outlook

Looking over the next twelve months we are focused on four big themes: (1) caution, more volatility ahead; (2) US equity: from leader to laggard? (3) live local, think global; and (4) can alternatives shine?

  • Caution, more volatility ahead – After an up and down 2015, we foresee more of the same ahead this year. Investors are nervous as the effects of slow global growth have seeped into many sectors and regions. As we already seen in the opening days of 2016, investors are skittish and quick to sell on a variety of factors – China slowdown, geopolitics, oil dynamics or the next poor economic report. As long-term investors we don’t overreact to every zig or zag, but we do search for attractive values in favored sectors or subsectors amid the choppiness.
  • US Equity: From Leader to Laggard? – We assess the prospects of US equities on three key factors. Two factors are slight negatives weighing on stocks – most valuation measures are high historically and the Fed has begun raising interest rates. The third factor, earnings growth, could provide support for gains in 2016. If reported profits hit the forecast range of +5% to +8%, then positive stock returns may follow. While the path won’t be smooth, we believe there is opportunity for gains in some sectors.
  • Live Local, Think Global – While the US central bank has taken its foot off the stimulus accelerator, other central banks, such as the Bank of Japan and the ECB, are still looking for levers to stimulate their economies. Emerging markets have taken a beating and their near term prospects look weak given their exposure to China and to commodities. That said, valuations are becoming more interesting and not all of them are handcuffed to China or commodities. While perhaps not attractive for near-term performance, we see hints of opportunities on the horizon for long term investors.
  • Can alternatives shine? – Alternative investments try to produce returns that are not correlated to general stock and bond market indices. Given the current low market return expectations, we are overweighting portfolio allocations with a set of non-traditional investments that seek positive returns with risk-buffering benefits. This could be an area of relative opportunity this year.

Casting a Wide Net

Our managed risk asset allocation portfolio strategy is based on using a diversified set of investments. In today’s environment, we believe that using a wide range of return opportunities is critical to deliver both returns and manage risk. At present, we are taking action in the following areas:

  • Over- and underweighting key sectors – Based on our market view, we are overweight growth stock sectors and high yield, and underweight government and corporate bond holdings.
  • Increase alternative investments – We are increasing the number and use of alternative investments, such as long-short equity funds, with the objective of producing positive returns while buffering market risk.
  • Opportunistic buying – Market volatility often creates opportunities in areas that we find attractive, like high quality growth stocks in tech, health care and financial stocks.

While we are following this scenario, we are constantly monitoring market developments, and remain flexible to adjust to new data as the year unfolds.

Happy (Choppy) New Year

The holiday decorations are barely put away and the market has stopped wishing us a good start to the New Year. The news cycle is feasting on Chinese economic slowdown, stock market volatility, oil prices and currency devaluation. As we often do during times like these we remind ourselves that we are long-term investors. What does it mean to be a long-term investor? A long-term investor is someone who believes that over time the global economy will grow and valuations on equity investments will appreciate. If we no longer believe that this will occur then it would be time to completely rethink our expectations on working, spending, and saving, not just our investment strategy. Let’s look at what happened this week and ask ourselves whether we should abandon the long-term promise.

China

China had a difficult week due to a number of factors not least of which is the Chinese are still trying to figure out how to actually run a stock market. Our stock market is nearly 200 years old. China’s is less than 25 years old. We should expect that they aren’t going to every move right. They are starting to lift some trading restrictions and this created selling pressure. Yes, their economy is slowing down. We’ve know this for a while. The specifics on the Chinese economy are also hard to discern given the government’s control over most everything. Until the markets get more comfortable with China’s actual impact on the US and other markets, China will, at various times, create market volatility.

The US Economy

The US economy continues to give mixed signals. Improving employment numbers today! Slower manufacturing numbers tomorrow? For some time we have voiced our agreement with the lower, slower camp and still believe that will be the case for the foreseeable future. Maybe not great for stocks but not a set up for disaster either. So is it time to abandon our long-term approach? Is this the beginning of a deep bear market? We don’t believe so. It is much better to be patient during the difficult markets so that we don’t miss the good markets. To this point see the chart below. Forget about the impact on missing the best years. Look at the difference it makes to miss the best days!

This not to say we are sitting on our hands. We will send out our annual review and our outlook for 2016 in a few days and identify changes to our strategy in light of our view that this will likely be a choppy year even if eventually markets rise.

Time in mkt more valuable timing market

Source: Wells Fargo Investment Institute, November 2015
Stocks are represented by the S&P 500 Index. The data assumes reinvestment of income and does not account for taxes or transaction costs. Past performance is no guarantee of future results.
Chart is for illustrative purposes only and is not meant to represent the performance of any particular investment. An index is unmanaged and not available for direct investment.

It’s a Different World Down There

Like politics, the economy feels very local these days. Last week we were in Austin, Texas for spring break. What a difference from the northeast. Not just the weather, which would have been enough. From one vantage point I counted 12 building cranes in the city.  Tech is growing here and there is a big influx of talent every day.  There are quality condos within 15 mins of downtown for $100k. Parks, cool restaurants, music and an overall positive sense of opportunity that is so different you would think the financial crisis never hit.

Of course their economy was never as tightly linked to the ups and downs of the global capital markets and they are growing real economy businesses in a state with no income tax that’s not far from California.  And real estate did take a beating in the financial crisis so this could be the cresting of the wave before it crashes again.  They are dealing with major water issues.  Look at pictures of Lake Travis now and 10 years ago.  Still it was a nice change from the downbeat vibe of scarcity I often pick up in New England and the Tri-state area. It was an unexpected boost to my optimism for the economy, assuming Texas doesn’t make good on the seemingly annual threat to succeed.