2018 Quarter #2

Given the combination of (1) accelerating global economic growth; (2) sensible monetary policy support by central banks in the U.S., Europe and Japan; and (3) low but potentially rising inflation, portfolio positioning favors equities and real-asset alternatives over fixed income:

  • Long-term expected returns for all asset classes may be below returns experienced over the last 10 years; however, returns for equities could be well above those for fixed income for some time with higher volatility compared to the previous 18 months.
  • A number of exogenous threats (the biggest of which include a Federal Reserve Bank monetary policy misstep, tariff wars and a global economic slowdown led by China) could unsettle capital markets at any time, resulting in higher volatility than recently experienced.
  • U.S. equity valuations are relatively expensive, versus foreign-developed and emerging-market equity, and can experience market corrections at any time.
  • Alternatives should offer low-correlation inflation protection and differentiated returns compared to equity and fixed income.
  • Reduced allocations to fixed income and cash may be prudent given long-term headwinds, such as higher inflation.
  • Assuming your plan, risk tolerance and investment policy are aligned, long-term investors need not take drastic action.

Simply stated, the economic optimism derived from the “1-2 punch” of President Trump’s pro-growth and business-friendly fiscal stimuli in the form of lower taxes and reduced regulatory burden seems to be translating into better economic activity. During the first quarter of 2018, the economy grew at a rate of 2.9% on a year-over-year basis. This compares to the recovery average of 2.2% since the Great Recession and the best reading since the first half of 2015. Not bad at all.

However, we are also monitoring the ongoing dialogue surrounding tariffs and the international trade arena. If implemented broadly, these tariffs could artificially increase costs in some important areas of the economy resulting in lower economic activity and upward pressure on inflation.

Zooming out more broadly, economic growth in both developed and developing regions remains robust and continues to provide a favorable environment for global equities. We are in one of those rare moments when all the major regions of world (U.S., Europe, Japan, China and the other emerging markets) are advancing. Of course, this cannot last forever. One short-term risk for the market is the “second derivative effect” on economic growth. In other words, the rate of change cannot stay positive forever. At some point economic momentum will slow, and this may startle equities.

Getting a bit of a jump ahead of a recession is helpful because bear markets (sustained stock market declines of 20% or more) coincide with recessions based on our study of business cycles over the last 100 years. All said, our guess is the risk of recession in the next 12 months remains low and our portfolio positioning of increased equity and decreased fixed income exposure feels right.

While our exposure to U.S. equities is substantial, our preference remains for foreign-developed and emerging-market equities. This is supported by lower long-term valuation and more attractive growth profiles versus the expensive and slower-growth proposition in U.S. equities. The emerging-market sector has been and should continue to be the prime beneficiary of increased global economic activity. Foreign-developed equity earnings growth should continue to accelerate as central banks in Europe and Japan seem to be providing an adequate tailwind through monetary policy to support growth for the foreseeable future. As a result, we expect higher total returns outside the U.S. given the longer-than-expected business-cycle expansions.

Global real asset alternatives, such as infrastructure, natural resources and real estate investments, should do well if and when inflation rises.

Fixed income investments remain challenging as longer-term interest rates rise. The 10-year U.S. Treasury bond yield recently rose above 3%, an important psychological level last seen in the beginning of 2014. If economic activity shifts into a higher and more sustainable gear — growing at greater than 3% for a while versus the 2% average since 2009 — interest rates should continue to rise, causing more heartburn for fixed income.

And don’t forget the Federal Reserve Bank complicates everything. Raising short-term interest rates six times since December 2015, the Fed believes it has a green light to tighten even more, which we expect it will do in the near future. Recall, the Fed does not have a good track record raising interest rates and avoiding recessions. Their actions usually end in recessions.

The portfolio profiles outlined above may vary based on the individual investment objectives of your financial plan. As always, we very much appreciate and value the trust and confidence you place in our firm. Please do not hesitate to contact your advisor with any questions or service needs.

Contact Russell Moenich to learn more about this topic.
330.255.4330 | rmoenich@sequoia-financial.com

 

 

This material is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy or investment product.  The opinions expressed do not necessarily reflect those of author and are subject to change without notice.  Diversification cannot assure profit or guarantee against loss. There is no guarantee that any investment will achieve its objectives, generate positive returns, or avoid losses. Sequoia Financial Advisors, LLC makes no representations or warranties with respect to the accuracy, reliability, or utility of information obtained from third-parties. Certain assumptions may have been made by these sources in compiling such information, and changes to assumptions may have material impact on the information presented in these materials.  Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment advisor does not imply a certain level of skill or training.