The Circus that is the White House

As the S&P 500 steps outside of it 2 standard deviation comfort zone for the 12th time this year, investors are experiencing record volatility.  Although the media may be quick to point the finger at President Trump’s temperament and rash decision making, a deeper look at the data shows the 10-year bond has stepped outside of 2 standard deviations 14 times year to date. Crude oil is even more volatile at 17 times, during a time of relative peace in the middle east.  This month’s issue of The Samra Report looks into factors that will continue to plague investor portfolios throughout 2018 and provides recommendations on dampening volatility while capturing upside growth.

There is no questioning the President’s methods are less than conventional, less thought out, and less permanent.  However, global financial markets are affected by a near infinite number of variables.  The most important of which are fundamentals, which continue to point to strong growth in 2018.  Domestically, “Outlook for the US economy is strong, as fiscal stimulus provided by the tax cuts and the budget deal should boost growth in the near term”.  Combined with the lowest unemployment rate of 3.8% since April 2000, and wages picking up steam.  At Samra Wealth Management we expect the S&P 500 to finish the year strong, with a minimum of 8% returns, carried by thriving technology and the consumer discretionary sector, specifically Amazon.  Although fundamentals are strong, investors should remain cautious with sector allocation.  We believe the 2 biggest threats to domestic markets are Regulatory Risk, and the Feds decision to raise interest rates at an unsustainable pace. 

  • Technology, our most overweight industry, which makes up 24.7% of the S&P 500, is the most globally exposed sector.  With strong global growth, fundamentals, and the largest beneficiary of repatriation, our biggest concern in Technology is regulatory risk.  Regulatory risk in the forms of increased scrutiny by global lawmakers, in the aftermath of data breaches, data usage and manipulation, and President Trump’s personal vendetta against technology in the absence of Real Estate. 
  • The Federal Open Market Committee is out of touch with the financial climate of the United States.  “The Fed often emphasizes the price inflation measure for personal consumption expenditures (PCE), produced by the Department of Commerce, largely because the PCE index covers a wide range of household spending.” The Fed, however, should place an increased emphasis on core inflation, “the most common type of core inflation measures excludes items that tend to go up and down in price dramatically or often, like food and energy items”.  Given the volatility of crude oil, combined with threats of a trade war, President Trump’s man at the Federal Reserve, Chairman Jay Powell would be wise to think dynamically.  An aggressive approach would be detrimental to the majority of American’s dependent on lending at low rates, and a strong dollar.
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With interest rates expected to rise this month, investors should be extremely cautious on how to invest during the rising rate environment.  In our January edition of The Samra Report, 2018: The Year Ahead, we recommended investors decrease their allocation to fixed income, and look towards convertible bonds, and structured notes.  The above chart highlights this strategy, showing the Barclays Convertible Securities Index to significantly outperform the Barclays Aggregate Bond Index.  Investors following this strategy, should expect to see increased volatility within their portfolios.  For those investors who can stomach this rollercoaster ride we recommend they invest with a “risk on” philosophy, as history has shown the S&P 500 to significantly outperform treasury bonds during times of rising, and falling interest rates, highlighted in the chart below:

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As global financial markets continue on a confused trajectory, we reiterate the recommendations provided in 2018: The Year Ahead, mainly: Investing in Technology (12.78%), Healthcare (0.67%), Financials (-1.88) and Industrials (-1.12).  Following this philosophy year-to-date would have allowed investors to avoid the four worst performing sectors of the S&P 500: Consumer Staples (-13.54), Telecommunications (-12.55), Real Estate (-4.28) and Materials (-2.67).  Furthermore, we recommend investors take on a global outlook, and be cautious on when to hedge and not to hedge currency risk.  In January we made the following prediction: “Behind the U.S. Japan is our favored market, given the Bank of Japan’s continued stimulus and resilience to both Brexit and the U.S. Election, with low inflation these stimulus measures by the BOJ look to provide a jolt to the Japanese equity markets.  Snap elections boosted confidence, with continued Quantitative easing, increased spending towards military and a weakening Yen against the dollar, causes concerns of foreign-yield risk, and we therefore recommend any investments in the Japanese markets be made on a currency hedged basis.”  The difference in hedging this currency risk with regards to investing in Japan, for US investors year-to-date would have yielded an excess return of 0.70%, over a non-hedged strategy, with significantly less volatility, as shown in the chart below.

It is our recommendation, investors holding fixed-income assets such as government bonds, contact Samra Wealth Management for a portfolio shock analysis, highlighting the potential loss of value during an interest rate hike.  Investors would be wise to consider a managed investment philosophy over passive themes.

 

 

 

 

 

All information contained herein is derived from sources deemed to be reliable but cannot be guaranteed.  All economic and performance data is historical and not indicative of future results.  All views/opinions expressed herein are solely those of the author and do not reflect the views/opinions held by Advisory Services Network, LLC. The information and material contained herein is of a general nature and is intended for educational purposes only.  This does not constitute a recommendation or a solicitation or offer of the purchase or sale of securities. Before investing or using any strategy, individuals should consult with their tax, legal, or financial advisor.

Stock Index prices are listed as of the close of business May 31, 2018, and do not take into consideration any reinvested dividends.

 

 

References

Blanch, F. and Fischer, P. (2018). THE RIC REPORT - Positioning for Rising Interest Rates. [online] Olui2.fs.ml.com. Available at: https://olui2.fs.ml.com/MDWSODUtility/PdfLoader.aspx?src=%2fnet%2fUtil%2fGetPdfFile%3fdockey%3d6208-11869122-1 [Accessed 29 May 2018].

Bloomberg.com. (2018). SPX Quote - S&P 500 Index. [online] Available at: https://www.bloomberg.com/quote/SPX:IND [Accessed 1 Jun. 2018]

Board of Governors of the Federal Reserve System. (2018). The Fed - What is inflation and how does the Federal Reserve evaluate changes in the rate of inflation?. [online] Available at: https://www.federalreserve.gov/faqs/economy_14419.htm [Accessed 28 May 2018].

Eresearch.fidelity.com. (2018). Sectors & Industries Overview - U.S. Sectors- Fidelity. [online] Available at: https://eresearch.fidelity.com/eresearch/markets_sectors/sectors/sectors_in_market.jhtml [Accessed 1 Jun. 2018].

Lanman, S. (2018). Fed’s Core-Inflation Gauge Expected to Round Up to 2% Goal in March. [online] Bloomberg.com. Available at: https://www.bloomberg.com/news/articles/2018-04-12/fed-s-core-inflation-gauge-seen-rounding-up-to-2-goal-in-march [Accessed 28 May 2018].

Samra, I. (2018). 2018: The Year Ahead. [online] SAMRA WEALTH MANAGEMENT. Available at: http://www.samrawealthmanagement.com/market-commentary/2018/1/3/2018-the-year-ahead [Accessed 28 May 2018].

Senior Professional Economist, S. (2018). PCE and CPI Inflation: What’s the Difference?. [online] clevelandfed. Available at: https://www.clevelandfed.org/newsroom-and-events/publications/economic-trends/2014-economic-trends/et-20140417-pce-and-cpi-inflation-whats-the-difference.aspx [Accessed 29 May 2018].