Q4 Investment Strategy Meeting Summary
We held our Q4 investment strategy meeting on September 28,
2016. With respect to macro fundamentals, we do not see much change from last
quarter’s meeting. We view the U.S. economy currently mired in a “2% world”, meaning 2%
GDP growth and 2% inflation. The U.S. economy is actually growing less than 2%
so far this year, but we expect some acceleration in second half GDP growth.
There are signs that U.S. inflation may be accelerating somewhat as a result of
moderate upward pressure on wage growth; however, at this point, we continue to
expect overall inflation to remain moderate. In terms of the global outlook, it
appears that China’s economy has stabilized as a result of government measures
to prop up growth; however, the estimated long-term growth rate for China’s
economy is coming down. While the stabilization in China’s economy is positive
for global growth, the slower expected growth in China could act as an
additional factor keeping global growth relatively subdued.
We continue to view Federal Reserve policy as accommodative
to the financial markets. It is clear from last week’s FOMC meeting that the
Fed continues a relatively light hand with respect to interest rates. While we
expect a fed funds rate hike in December, the latest FOMC meeting shows that
the Fed has backed off its expected number of rate increases for 2017 and 2018
with the majority of FOMC now expecting only two rate hikes in each year, down
from the previous four in each year. This is significant and indicates the Fed
expects to remain gradualistic in its approach to monetary policy. The
implication of this for the financial markets is positive, particularly for
equities. This plus an improving outlook for corporate profit growth are
reasons why we remain constructive towards stocks.
We made several tactical changes to your portfolios
following the meeting. We increased exposure to equities slightly. Within the
mature (large cap) equity area, we added a position in the biotechnology
industry (IBB) as we believe health care remains an attractive secular growth
story and biotech in particular appears undervalued. Within developing equity,
we added a position in small cap value stocks (VBR), which we believe offer
attractive value. We also continue to maintain a position in the homebuilding
industry (ITB) which we view as one of the strongest sectors of the U.S.
economy. Within the international sector, we added a small position in the
emerging markets area (VWO) as we believe that sector will benefit from
stabilization of the Chinese economy. Within natural resources, we added a
position in energy (XLE) as we believe the outlook for oil prices should
improve and valuation remains relatively attractive. Our overall exposure to fixed
income remained unchanged. While we reduced exposure to long bonds, we increased
exposure to short maturity bonds and increased portfolio yield through the
addition of a shorter-term high yield bond ETF (SHYG).
In our objective to manage risk in your portfolios, we set a
“trigger” at our meeting that would
cause us to reduce market exposure under certain conditions. The reason
for this is our concern over the potential for increased market volatility
around the upcoming presidential election. Historically, the presidential
election can be a time of heightened stock market volatility and we believe it
could be somewhat more acute this time. Our trigger is based on a combination
of two factors: the combination of 1) a closing price on the VIX (forward
implied CBOE volatility index) exceeding 20.0; and 2) a closing price on
the S&P500 below 2000. We believe this combination would signal to us that
market volatility may be increasing at a pace faster than we feel comfortable
with and which would justify some action to reduce exposure.
