Our investment management process is built on the idea that behavioral economics is a major factor in successfully achieving the goals of an investment plan, especially for individual investors and families. We believe that we can help investors improve results through the use of techniques inspired by behavioral economics, such as our risk-first approach, blending strategic and tactical investments together, and having an airbag methodology like our Cash Indicator. We are very excited that the 2017 Nobel Prize in Economics was awarded to one of our biggest influences, Dr. Richard Thaler, for his work in the field of behavioral economics. We thank Dr. Thaler for his inspiration and congratulate him on this honor.
Regarding the U.S. economy, we think the current business cycle can continue for years on the condition that the U.S. Federal Reserve (Fed) does not make a significant policy error. Up to this point, we have been comfortable with the Fed’s policy moves since the spring of 2016 when they put further rate hikes on hold until this past December.
Meanwhile, global central banks continue to employ stimulative policies that should allow economic growth to continue. While the Fed is expected to raise short-term interest rates again, in addition to slowly reduce the size of its balance sheet, both the European Central Bank (ECB) and the Bank of Japan (BOJ) continue to stimulate the global economy through low interest rates and balance sheet expansion (exhibits 1 and 2).
The GOP released the outline of a tax reform plan that will likely only have a marginal impact on the economy. Aside from a near-term boost based on optimism, we expect that any material increase in economic activity will be offset by tighter Fed monetary policy. The Fed has stated that they think inflation risk is building and an increase in economic activity from a tax stimulus will likely be met by a more aggressive stance.
We think U. S. real GDP growth for the remainder of 2017 and 2018 is likely to be around 2.0% – 2.5% annualized. Adding 2.0% for inflation brings us to our nominal GDP forecast in exhibit 3 below. The signals we track generally suggest an increase in economic activity continuing the rest of this year and into the next due to gains in consumer spending and business investment.
The global economy is likely to continue growing for years, which should create a constructive atmosphere for equity investors. A growing economy increases the potential for corporate revenue and earnings growth (exhibit 3). As a result, and despite periods of volatility, we expect equity prices to march higher.
Importantly, healthy economic news is not exclusive to the U.S. economy. For example, Japanese exports are up 18%. Meanwhile, Germany’s factory output increased by almost 3% in August, its biggest increase in six years.
That said, long-term interest rates will likely remain range bound near their current levels. We think that insatiable global demand for high quality debt will keep interest rates low. Market-based inflation expectations have also dropped since last fall’s economic optimism (exhibit 4), which reduces upward pressure on long-term rates.
Overall, we have a constructive view towards the global economy. Most of the leading indicators we follow are in positive territory, consumer spending is solid and capital expenditures appear to be on the rise.
INVESTMENT IMPLICATIONS
Within our equity allocations, we are favoring the financials, health care, industrials and materials sectors. We maintain our value bias despite it lagging growth this year. We think the recent outperformance of domestic growth stocks relative to value has mostly run its course (exhibits 5 and 6). Our equity allocations are trading at roughly a 10% discount to the global equity market due to our value bias. Furthermore, our strategies have a significantly higher yield than the market. Trading at a discount and getting paid to wait sounds like a good formula to us right now.
We are also emphasizing developed market equities, such as Europe and Japan. While domestic equities and emerging market stocks are trading at a premium to their historical average valuations, both Europe and Japan are trading at discounts. Emerging markets have surged this year, and we think their return expectations over the near-term should be lowered. As a result, emerging market stocks is one of our larger underweights.
Regarding our fixed income and alternative allocations, we think credit spreads are tight, so we pared back our exposure to corporate bonds. We have found several return enhancing and risk management opportunities in broadly diversified ETFs that blend allocations to REITs, MLPs, and dividend payers, as well as more focused holdings, like convertibles, bank loans, and preferreds. Again, without stretching for yield, our strategies can produce more income than the market.
In general, U.S. equities seem a little expensive to us, though we are interested in the sectors previously mentioned. We are also finding opportunities in Europe and Japan, where valuations remain attractive and economic fundamentals are improving. We are not long-term bulls on either region, but find them favorable for the time being.
THE CASH INDICATOR
The Cash Indicator (CI) has declined to the low end of its historic range. While we expect market volatility to increase, the current level of the CI suggests that the environment for raising significant cash is a long way off.
This article was written by Gary Stringer, CIO, Kim Escue, Senior Portfolio Manager, and Chad Keller, COO and CCO at Stringer Asset Management, a participant in the ETF Strategist Channel.
DISCLOSURES
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management, LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not be taken as an advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested.
Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.
The securities identified and described may not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in the securities identified was or will be profitable.
Data is provided by various sources and prepared by Stringer Asset Management, LLC and has not been verified or audited by an independent accountant.
Index Definitions:
S&P 500 Index – This Index is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of a broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Russell 3000 Growth – This Index is a market capitalization weighted index based on the Russell 3000 index. The Russell 3000 Growth Index includes companies that display signs of above average growth. The index is used to provide a gauge of the performance of U.S. growth stocks.
Russell 3000 Value – This Index is a market capitalization weighted index based on the Russell 3000 index. The Russell 3000 Value Index includes companies that display lower price-to-book ratios and lower expected growth rates.