Volatility is back and it’s not a bad thing. Three of the most universal human traits are herding instincts, risk aversion, and the need for conclusive narratives. All are rooted in 5,000 years of evolutionary development and they were on full display over the last week.
After sitting out most of the 2009-2017 risk assets’ rally, retail investors piled into the markets over the last eight months. They bought exotic instruments like Bitcoin, leveraged indices and VIX products. Then when the financial media began touting “the end of the 36-year bond bull market & impending equity markets correction” on the back of a recent surge in interest rates, they all tried to run for the exits at the same time.
And now, everyone is looking for a narrative to explain the fastest fall from a record high in S&P history – 10% in only 9 days. Here’s a good one: nothing has changed in our fundamental credit macro outlook, and if anything, the rise in rates has finally caught up with the US Federal Reserve outlook—meaning it would take a huge uptick in inflation to drive higher rates from here. And here’s another one: the VIX products that vaporized investor money were worth less than $5 billion in aggregate so they weren’t about to bring the market into a systemic crisis. Louis Gave’s question — “Why would regulators even allow things like 3x levered Brazil ETFs, or inverted VIX ETFs, which will inevitably go to zero in a time of market stress?” — is one that market professionals should be thinking about. Getting a taste of trouble and thus avoiding speculative traps last seen in 2008 is a good thing for markets.
We are positioned in our Global Tactical portfolios to potentially capture global opportunities and avoid “problem” regions and sectors. It is certainly possible that the US Federal Reserve has “overshot” in withdrawing liquidity and raising rates given the disinflationary environment we inhabit that impacts employment—robotics, advances in artificial intelligence, and giant corporations forming healthcare consortiums come to mind. Even so, it’s good to remember that financial conditions are very “loose” and interest rates are extremely low in almost every developed and important emerging market (EM) country.
- We hold a small tactical cash position in our GTC and GTA portfolios. While we remain constructive on equities, a better entry point may present itself in the near future.
- We are avoiding foreign currency fixed income to benefit from higher US dollar interest rates. We expect spreads between US dollar and foreign currency interest rates to narrow, and therefore will benefit by concentrating all of our fixed income exposure in US dollar denominated
- We are avoiding long duration fixed income in our portfolios. Interest rates may continue to rise as economic growth remains strong, inflation reemerges, and global central banks step away from the “extraordinary measures” they employed during the financial crisis.
- We have exposure to four US equity sectors: financials, technology, energy, and aerospace & defense. Financials benefit directly from a higher interest rate environment in the US, as well as a more favorable tax and regulatory environment. The pace of disruption of old industries by new products and processes has continued to accelerate, and technology gives us exposure to this process of creative destruction. Strong economic growth will support global energy markets, and inflation may reemerge in 2018, which will support the energy sector. Global military spending will increase in coming years, as US hegemony fades and a multi-polar world emerges—the aerospace and defense industry will be a beneficiary.
- We have exposure to hedged-currency Eurozone equities. A German “grand coalition” government has been agreed to, which brings much needed stability to the region. We have hedged our exposure to the Euro in order to benefit from a stronger US dollar.
- We have exposure to both large- and small-cap Japanese equities. They are supported by favorable valuations, accelerating economic and earnings growth, the Bank of Japan’s ongoing aggressive monetary easing, and global money managers’ underweight exposure. We have not hedged any of our Yen exposure.
- We have significant exposure to emerging market equities, which benefit from positive capital inflows and represent attractive relative value. We expect global capital flows to remain supportive and emerging market equities to continue to “catch up” after years of underperformance. Asia, in particular, represents an excellent opportunity.
- We hold a position in global agriculture equities. Increasing inflationary pressures and underweight investor positioning should support the industry in 2018.
- We hold positions in broad commodities and gold. We expect inflation to rise in 2018, which will support commodity markets.
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The investment descriptions and other information contained in this Markets in Motion are based on data calculated by W.E. Donoghue & Co. LLC (W.E. Donoghue) and other sources including Morningstar Direct. This summary does not constitute an offer to sell or a solicitation of an offer to buy any securities and may not be relied upon in connection with any offer or sale of securities. This report should be read in conjunction with W.E. Donoghue’s Form ADV Part 2A and Client Service Agreement, all of which should be requested and carefully reviewed prior to investing.
The Global Tactical Allocation Composite (“Composite”) was created on 1/1/2004. The Global Tactical Conservative Composite (“Composite”) was created on 1/1/2004. The Global Tactical Income Composite (“Composite”) was created on 9/1/2012. The Global Tactical Growth Composite (“Composite”) was created on 2/1/2015. From 01/01/2004 to present, John Forlines III, Chief Investment Officer of W.E. Donoghue (the “CIO”), and Robert Shea, President of W.E. Donoghue (the “President”) were primarily responsible for the management of the representative JAForlines Global (JFG) composites while the CIO and President were principles at JAForlines LLC. W.E. Donoghue acquired 100% of the assets of JFG on December 29, 2017.