Monthly Outlook: February 2017

Markets are off to a good start this year and our portfolios are participating with gains. Growth assets did their part, providing gains across the board. U.S. stocks (Russell 1000) gained 2.0% in January while international stocks (FTSE All‐World ex USA) did even better with a healthy gain of 3.4%, mostly from Japan and emerging markets. Commodities and REITs were mostly flat. Stability assets were, indeed, stable but lackluster. Intermediate term bonds (Barclays Aggregate) contributed just 0.1% in January, but short‐term bonds did a bit better with 0.3% returns. So bonds added much‐needed stability, but held back portfolio returns. All in all, depending on your objective and mix, globally diversified portfolios are up 1% to 2% in the first month. This is the best January since 2013, when our iFolios Growth model annual benchmark return was 12.5%. We can’t promise these returns for 2017, but it’s a nice thought!

The Elephant in the Room: Trump

As money managers, it’s not our place to be political but we certainly have to consider the current political environment as it affects investments. So far, it’s clear that Trump and his administration are pushing through people and policies rapidly. As Ray Dalio of Bridgewater hedge fund ponders, “Will he be aggressive and thoughtful or aggressive and reckless?” So far, markets seem focused on, and pleased with, pro‐growth policies from lower taxes, less regulation, and infrastructure plans. On the other hand, markets seem to be ignoring (so far) the negative aspects of restricting global trade with tariffs, restricting immigration, and the continued civil disruption and divisiveness that his style and rapid‐fire policy making provoke. This year may depend less on fundamentals and more on politics than ever before. And for the first time, it can change as quickly as one can tweet. Again, we’re not making political commentary here, just pointing out how focused we’ll need to be to balance growth and protection this year. It’s likely that we’ll have more volatility in 2017 and perhaps a few more trades than normal. But we’re ready for it.

Equity Trends are Still Up

Although we’re well aware of valuation and political risk for global equities, we’re also mindful of the price trends which remain in “up” trend mode for all global equity asset classes (e.g. U.S. Large, Europe). As long as the trend is higher, we must remain fully invested – even if nervously – to capture the growth while we have the opportunity. It’s also worth pointing out that our downside risk is always limited, given our iFolios strategy. Let’s use the S&P500 as an example. Today, the S&P500 is at 2,275. Its trend‐line (the 200‐day moving average) is at 2,160 and rising. That will serve as our “line in the sand” where we would sell or trim to reduce downside risk and move to protection mode. That is only 5% downside risk, compared to unknown upside potential. That’s a fair trade‐off.

Monetary vs. Fiscal Stimulus

For years, the U.S. Federal Reserve has provided unprecedented monetary stimulus to help the economy recover from the financial crisis of 2008. That primarily involved lowering interest rates using the “Fed Funds rate” and various quantitative easing programs like QE1, QE2, etc. The point is that the Fed has done all the heavy lifting of stimulus so far. And it seems to have helped. Corporate earnings are rising, unemployment is down to a very low 4.7%, and inflation is mostly in check. Now that the stimulus is no longer needed, the Fed has clearly signaled that they will begin unwinding monetary stimulus and will gradually raise interest rates back to normal levels. But as the Fed is tapering stimulus, the Republican led Congress and White House are proposing massive fiscal stimulus including tax reduction and spending on infrastructure. It’s curious why one branch thinks stimulus is no longer needed while another thinks it is. We’ll have to watch whether monetary policy fights fiscal policy with faster tapering and higher rates.

Last Thought: The Super Bowl Predictor says that if the NFC team wins, the stock market will be up for the year. It’s been right 40 of 50 years. You might want to root for the Atlanta Falcons!