3Q 2017 Commentary
Turkey: tur-key / noun/ three consecutive strikes in bowling
This was the third consecutive quarter that both equities and bonds delivered positive returns. This is not typical, but who’s complaining? We will enjoy the outsized returns for as long as they last.
Q3 Major Themes to review:
- The U.S. dollar continued its slide versus other major currencies, contributing to the outperformance of foreign stock and bond markets. In fact, the loss in value of the dollar this year has been one of the largest drops in decades.
- U.S. GDP has rebounded impressively. The latest reading on domestic economic output is 3.1%, well above recent readings. If this administration is able to pass tax reform, GDP should continue to impress.
- The global economy as a whole is in the best shape we’ve seen in years. Japan’s latest GDP reading was 4.0% and Europe’s structural reforms since the Great Recession have begun to bear fruit
- Economic data will be volatile over the next few months due to unprecedented hurricane damage.
- The Fed will most likely raise rates again at the end of the year and continue its path of rate normalization in 2018.
- We believe that U.S. stock prices are slightly elevated by historical standards, but remain cheap relative to bonds and cash.
- We believe that the current bull market should continue its advance as long as corporate earnings continue to improve and the Fed raises rates in a slow, methodical fashion.
- We believe that foreign equities remain a better value than U.S. stocks on a relative basis.
- We believe that in the coming months, volatility will pick up in the equity markets based on Fed-speak, mixed economic data and the possibility that Trump’s tax plan will not pass until 2018.
- We believe that selectivity is important, so allocating to actively managed, higher conviction investments is just as important as owning broad market index investments.
Foreign stocks have consistently outperformed domestic markets in 2017. Resurgent economic data, monetary policy, and more attractive valuations are all contributing factors.
Fixed Income Overview
- We believe that bonds are an essential part of a well-diversified portfolio.
- We believe that although bond yields are quite low by historical standards, they still provide a valuable hedge against equity risk.
- We believe that at this time, the sweet spot along the yield curve is in the 4-5 year range from a risk/return standpoint.
- We believe that at this time, investment grade corporate bonds are more attractive than Treasury bonds.
- We believe that non-traditional bond investments offer additional levels of diversification and greater return potential than traditional bonds.
Consistent with foreign stocks outperforming U.S. stocks, foreign bonds have significantly outpaced their domestic brethren in 2017. This can be predominantly attributed to the tremendous movement in currency valuations.
Through Q3 of this year, both our traditional and non-traditional fixed income holdings in total have outperformed the benchmark Bloomberg Barclays U.S. Aggregate Index with less interest rate sensitivity. This is primarily due to our bias for higher yielding, medium grade corporate credit as opposed to lower yielding and more expensive government debt instruments.
As we head into Q4, global events such as North Korean aggression, tax reform debates, and October’s snap election in Japan will likely cause an increase in market volatility. Obviously, a stock market correction could occur at any time, but strong economic underpinnings remain in place; low unemployment, modest wage inflation, strong corporate earnings, and a pick-up in capital expenditures all point to the overall health of the economy. That said, these factors could prime the pump for a rise in inflation heading into to 2018.