Momentum Unlikely Future Elixir

Note Précis July 19, 2017: We espouse diversification including precious metals. In capital market exposure geographically, in asset class and among companies alike, key is selectivity based on balance sheet and operating strength. There appears performance risk in the erstwhile consensus complacency about long fixed income, leverage and low volatility. Contrary to the hyperbole of recent years, the elixir for investment outperformance has not been found nor does it seem to lie in reliance on momentum nor in hedge funds. Contrary to recent folklore, central banks have not been as omnipotent nor as omni prescient as the market complacency appears to continue to be based upon. We have long believed the last quantitative ease tranche from the Federal Reserve as having been unnecessary and as having likely accentuated asset price distortions rather than facilitating economic growth. In a path to U.S. policy normalization, we believe that Fed Funds rates could rise to peak at 3.50% by early 2019.

In global politics ranged from economics within Europe to strife raging within and from the LeVant to terrorism, however defined, tensions abound. Meanwhile in the United States, cyber terrorism and political turmoil appear drawing attention despite the urgency of budget policy matters. Obfuscation on fiscal matters has become a global phenomenon, accentuated by quantitative ease. We believe the actual delivery of growth and restructuring needs more attention than the markets have given so far. Capital market volatility has reason to rise.

Clarity on Federal Reserve policy and higher rates in the United States are likely to bolster the U.S. dollar could complicate already fraught trade tensions and pressure extended fixed income. We would favor underweighting fixed income and tilting holdings towards the short to medium term maturities by overweighting U.S. dollar exposure as well as areas like the Australian and Canadian dollar rather than the present seeming fervor for junk bonds and emerging country debt both of which have credit risk. Were earnings growth for the S&P 500 to be closer to 6-7% that has been of historical norm and appears currently indicated, it would likely be insufficient to buttress valuation. Less conducive quantitative ease would make both equity buybacks and reported earnings management harder. On rigorous analytics, companies on capital budgeting would be unlikely to use a project rate of return hurdle rate of low single digits. In the present era of closer correlations, these aspects are likely to affect growth and value investment strategies as well as geographical mix.

We expect greater selectivity in equity markets. In contrast to recent performance, not all growth segments offer appeal nor do all value segments offer defensive attributes, notwithstanding dividends. In our view, selectivity based on operating delivery, financial strength and valuation also count for more than reliance on geographical diversification or momentum. On market leadership, we expect the U.S. to be crucial overall and emerging markets to be so for growth, albeit with bifurcation in both. In sector selection and leadership, we see the Financials as crucial and to be overweight utilizing those continuing and earliest into restructuring. In terms of under recognized restructuring and underappreciated for its crucial role in products well beyond fuel, we favor Energy. On business cycle and change, we underweight consumer areas despite their size in many economies to instead favor Industrials and Materials for restructuring and for precious metals as diversification. For growth and despite its outperformance, we favor Information Technology as overweight over Healthcare that faces consolidation amid less than defensive valuation.