Given the persistent combination of low inflation, modest global economic growth and extraordinary monetary policy support, we continue to favor a balanced portfolio between equities, fixed income and alternatives with a modest overweight in equities. 
 
  • 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
  • The environment for financial assets remains favorable thus far in the recovery; equity, fixed income, and alternative asset valuations are not so stretched as to be characterized as a bubble waiting to burst
  • Financial assets may remain well supported with some downside risk; a number of exogenous threats (the biggest being a global economic slowdown led by China and a Federal Reserve Bank monetary policy blunder) can continue to unsettle markets, especially given relatively full valuations and the fact that we have not experienced a bona fide equity market correction in years
 

CAPITAL MARKET PERFORMANCE & ASSET ALLOCATION COMMENTARY

After two unexciting quarters of asset class return performance, the broad sell-off of most asset classes in the third quarter was sudden and vicious as most sell-offs are. However, the most recent move is somewhat unique in that the damage was so wide-spread across all asset classes. Generally, some portion of a broadly diversified portfolio – e.g. fixed income – acts as a strong “safe haven” in times of volatility. That was hardly the case this time around.
 
We would gladly take the “unexciting” over the “sudden and vicious” anytime, anywhere, and twice on Sunday!
 
The global sell-off event that culminated in an August broad market downdraft started with a Chinese equity correction in mid-June. As a result economic growth concerns in emerging markets (especially China) fed further market declines. 
 
The focus on China should not be a surprise. It is a country that arguably exerts more influence on the world than the U.S. economy. While China’s economy is still smaller than the U.S. economy, it is a bigger contributor to global growth, even after applying a healthy discount to the official gross domestic product (GDP) data published by the Chinese government. The U.S. is a relatively “closed” economy, with lots of economic activity linked to services and consumption and little from external trade. By contrast, China’s trade links (both as an importer of capital goods and commodities and a large exporter of the former) cast a long shadow across much of the developed world.
 
The numbers are worth considering. China accounts for more than a quarter of the world’s saving as well as investment (the same size as the U.S. and Europe combined), and it is the home of the world’s four largest banks by assets. Most importantly, its economy is in a state of rapid flux as it tries to wean itself away from investment-driven growth in infrastructure and real estate – and the world is now paying attention! The biggest question: how successful will China be at transitioning from an investment-led economy to one powered by consumption and what will the ensuing hit to growth be? It will be impossible to answer this question in the next quarter or even the next year. The China story will be a focus of global investors for a long time to come.
 
Another – and, in our opinion, larger – factor adding fuel to the sell-off fire during the third quarter was investor comfort with the U.S. Federal Reserve Bank (Fed) gearing up for the first hike in short-term interest rates in almost a decade. While the Fed has been signaling its intentions (now focused on a December rate increase) for some time, market participants are worried that both the U.S. and global economies are still too fragile and not ready for an interest rate increase from 0% today, to even a mere 0.25% increase. Look no further than the fact that the broad unemployment rate is still elevated, inflation is nowhere to be found, and the economy has only averaged about 2% year over year growth since 2010. Hardly a rationale for any change in monetary policy.
 
Given the above, we are more cautious about the global economy than we have been in several years. While we believe fears of a global recession are overblown, growth is likely to remain mediocre in 2016 with some risk to the downside. Meanwhile, global assets are generally fairly priced even after the sell-off in the third quarter with few new pockets of opportunity.
 
 
Given the above, we are more cautious about the global economy than we have been in several years. While we believe fears of a global recession are overblown, growth is likely to remain mediocre in 2016 with some risk to the downside. Meanwhile, global assets are generally fairly priced even after the sell-off in the third quarter with few new pockets of opportunity.
 
 
 
Fixed income performance during the third quarter was under-whelming given the weak equity performance, as equity and fixed income performance tend to have low correlation to each other. In our last commentary to you, we mentioned the following:
 
The siren song of high yield can become tricky very fast. The high yield market, which is by definition dominated by “junk” issuers or those companies that do not have the best balance sheets and are not “investment grade.” While the market has been forgiving so far during this business cycle, at some point in the future that could change. As a result, we are less sanguine about the sector. From what we’ve seen since 2009, this sector has led the equity-market inflection points, meaning high-yield performance has been a great leading indicator for the future direction of equity-market returns. That relationship has reversed recently. With the potential for U.S. equity earnings to stagnate or fall and the Fed to tighten, we deem this enough to remain cautious about the high-yield sector. 
 
These comments were more prescient than we originally thought as the high yield fixed income sector was walloped during the past quarter.
 
 
We remain committed to having long-term exposure to alternative asset classes, i.e., not equity or fixed income, that strive to increase portfolio diversification, reduce risk and protect against unexpected inflation. While these sectors as a group appear to have added value over the last few years, we would expect a bigger contribution to our asset allocation in the event volatility in the equity and fixed income markets pick up. 
 
During the quarter and over the last year, not having any exposure to commodities and natural resources was helpful given the weak returns.
 
 

ASSET ALLOCATION THESIS: REMAIN OVERWEIGHT EQUITIES VS. FIXED INCOME & ALTERNATIVES

We are disciplined in our asset allocation methodology and will only choose attractive investment opportunities that meet our rigorous asset-class evaluation criteria (made up of qualitative assessments of valuation, momentum, and global macroeconomic effectiveness).
 

EQUITY 

In the U.S., there is minimal upside potential as valuations remain higher than historical averages with negative earnings revisions increasing over the past few quarters. The biggest challenge comes from the persistently bullish investor sentiment that has been pervasive for many years now. Going forward, U.S. equities may continue to lag behind foreign equities. 
 
Earnings are everything and the long-awaited recovery in European and Japanese earnings revisions seems to finally be here, which is in direct contrast to the U.S. earnings situation. European equities are valued favorably and should benefit from the European Central Bank’s (ECB) efforts to stimulate the economy. As a result, we would expect better economic data surprises and improved earnings growth. Japanese equity valuations are very low, and corporate behavior is changing, with a clear improvement in profit margins.
 
The relative valuation attraction of emerging-market equities vs. developed equities remains but has declined. Today there is a high level of dispersion within the emerging-market equity universe with select opportunities in emerging Asia and Europe.
 

FIXED INCOME

An improving global economy and a range-bound interest rate environment calls for moderate exposure to the more globally opportunistic areas of fixed income. We prefer full allocations to opportunistic fixed-income sectors and proven managers with broad mandates targeting tactical investments such as foreign developed bonds, Emerging Markets (EM) bonds, senior bank loans, high yield/junk-rated, convertible bonds and preferred stock when appropriate.
 
Fixed-income markets appear to have been very resilient in the face of Fed Quantitative Easing reductions and prospective interest-rate hikes; markets may be too complacent about the timing and speed of the Fed tightening cycle. Time will tell.
 

ALTERNATIVES

We remain committed to alternative assets such as hedge fund trading strategies and “real assets,” e.g., commodities, infrastructure, natural resources and real estate — which can have lower correlation to equity and fixed income, increase portfolio diversification and may help protect against rising inflation. 
 

GLOBAL MACROECONOMIC SUMMARY

We monitor a focused set of global leading economic indicators that cut through the economic noise and short-term anxiety to continually gauge our position in the business cycle. Our quarterly review of the economic trends in key geographic regions helps frame our portfolio asset-allocation decisions.
 

GLOBAL 

Leading economic indicators suggest mediocre global growth of 3.1% in 2H15; while 2016 maybe better at 3.4% vs. an estimated 3.1% in 2015 as a whole:
  • After six years of a global expansion, we are now moving into a phase of the global business cycle in which labor markets are improving and both wage growth and inflation appear to be bottoming, suggesting that the global recovery is becoming self-sustaining and that monetary policy will not be as overwhelmingly supportive 
  • The constructive trends of easier monetary policy and low oil prices, which had been in place since mid-2014, have stalled

UNITED STATES

While trying to maintain the role as leader of the global business cycle, U.S. economic growth remains choppy in a longer but less robust business cycle expansion: 
  • Lackluster 1H15 economic growth of 2.1% weighed down by weak Q1
  • Growth could average nearly 2.5% in 2H15 due to strength in consumer spending
  • We expect the economy to grow fast enough to continue to push the unemployment rate down and support Fed interest rate hikes in the future, though not this year
  • How long this cycle lasts from here will largely depend on Fed management: 
  • Business cycle expansions do not die of old age, but rather are killed by aggressive monetary policy: a sustained but mild business cycle expansion can continue, considering employment and inflation are below the Fed’s targets
  •  Every business cycle downturn over the last century (save 1930’s and 1981 ) came after the output gap went positive and unemployment fell to below average levels; the former is negative and the latter is above average

EUROPE

Reports of Europe's death have been greatly exaggerated, and economic growth seems set for a period of genuine recovery: 
  • Leading economic indicators predicting further acceleration in overall economic activity in coming quarters after 1H15 GDP surpassed expectations
  • The region is the largest beneficiary of the recent moves in global market and policy trends (aggressive monetary policy & lower oil/commodity prices)

JAPAN 

Prospects for Japan's economy look considerably better for the immediate future, although the bar is low: 
  • Q1 GDP surpassed expectations while Q2 GDP was below expectations
  • With the yen falling sharply in "trade-weighted" terms, exports - a key component of the economy - have rebounded significantly 

EMERGING MARKETS

Near-term outlook is less clear with diverging reactions to weaker oil/commodity prices (positive for China & India; negative for exporters) and a slowing China; positive long-term outlook driven by demographics remains a key thesis

The portfolio profiles outlined above may vary based on the individual investment objectives of your financial plan. As always we very much appreciate the trust and confidence you place in our firm. We value that trust every day and will continuously strive to retain it. Please do not hesitate to contact your advisor for any questions or service needs.

 

 

This document and the information contained herein is for information purposes only. It is not intended as, and does not constitute, an offer or solicitation for the purchase or sale of any financial instrument. The financial instruments and strategies discussed may not be suitable for all investors and investors must consider their own decisions based upon specific financial situations and investment objectives. Performance of an index is not illustrative of any particular investment. It is not possible to invest directly in an index. Past performance is not indicative of future results. This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified attorney, tax advisor, investment professional or insurance agent. Investment All information is believed to be from reliable sources; however, no accuracy is being made to its completeness or accuracy. Advisory Services offered through Sequoia Financial Advisors, LLC, an SEC Registered Investment Advisor. Certain Third-Party Money Management offered through ValMark Advisers, Inc. an SEC Registered Investment Advisor. Securities offered through ValMark Securities, Inc., Member FINRA, SIPC. 3500 Embassy Parkway, Akron, Ohio 44333, Phone (330) 375-9480. Certain insurance products offered through Sequoia Financial Insurance Agency, LLC. Sequoia Financial Group, LLC and related entities are separate entities from ValMark Securities, Inc. and ValMark Advisers, Inc.

i. Bloomberg