2017 Quarter #3
Given the combination of low but rising inflation, accelerating global economic growth and sensible monetary policy support, 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.
- A number of exogenous threats (the biggest of which include a Federal Reserve Bank monetary policy misstep and the growing gap between expectations and the future reality of U.S. fiscal stimulus) can unsettle capital markets at any time.
- U.S. equity valuations are relatively expensive versus foreign-developed and emerging market equity and have not experienced a bona-fide equity market correction in years.
- 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, caution is warranted tactically, but in our view long-term investors need not take drastic action.
The global equity markets continue to flirt with all-time highs because of accelerating economic growth despite dysfunction in Washington and fading hope for pro-growth and business-friendly fiscal stimuli. Our interpretation of the eventual outcome — higher corporate earnings growth with a smaller “kicker” from lower taxes, lower regulatory burden and higher inflation — confirms our portfolio positioning of increased equity and decreased fixed income exposure.
We continue to like long-term equity valuation and growth profiles outside of the U.S., such as foreign developed and emerging market countries, relatively better than the expensive and slower-growth proposition in U.S. equities. The emerging market sector should be the prime beneficiary of increased global economic activity. Foreign-developed equity earnings growth should be solid as central banks in Europe and Japan seem to be providing an adequate tailwind through monetary policy to support economic growth for the foreseeable future. As a result, we expect higher total returns outside the U.S. over the next five years given the longer-than-expected business-cycle expansions.
Real asset alternatives, such as infrastructure, natural resource and real estate investments, should do well in an inflationary environment.
We continue to expect fixed-income headwinds given the positioning of fiscal and monetary policy today, which make for interesting bedfellows. If President Trump and Republican policymakers are successful in bringing meaningful, pro-growth initiatives to fruition, such as lower taxes and lower regulator burden, the Fed may be quick to reign in the economy if there are any signs that inflation may get out of control.
The milder-but-longer-than-average global and U.S. (still the world's largest economy) business-cycle expansion is now 93 months old and may continue through 2017. No one knows when it will end — the longest U.S. business-cycle expansion in history lasted 10 years — but today there is a low probability that it will extend past 2018.
The Fed is in tightening mode after increasing short-term interest rates four times since December 2015. Interestingly, current financial conditions are “looser” than when the Fed started its interest-rate-hiking campaign. This suggests the Fed has a green light to tighten even more, which we expect it will do in the near future. One caveat: since the Fed was created in 1913, every business-cycle expansion — save the military resource drawdown after WWII — ended after sustained short-term interest rate increases by the Fed. The Fed does not have a good track record avoiding recessions. Of the 18 hiking cycles since 1913, only three ended with a “soft landing,” meaning without a recession: the mid-1960s, the early 1980s and 1994.1 Current times may not prove different, and we expect the Fed may make another monetary policy mistake by raising rates too far, too fast or both.
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.
August 3, 2017
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. Past performance is not indicative of future results. 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. Reference to an index does not imply that a portfolio will achieve return, volatility, or other results similar to an index. Performance of an index is not illustrative of any account, portfolio or strategy managed by Sequoia Financial Group. It is not possible to invest directly in an index. Investment advisory services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Registration as an investment adviser does not imply a certain level of skill or training.