November 28, 2016
Global Tactical and Strategic Asset Allocation and investment strategy/risk management consulting for asset owners and their advisor as an Integrated Investment Strategist -- chaired Investment Committees since 1997, 30 years experience
Ruthlessness of Unruly Forces
Investment Outlook – 4Q/2016
- Investors
want to know what matters most and how markets will respond to recent
geopolitical events, including the U.S. election, as well as upcoming European
elections and the Italian referendum. Many citizens are concerned about what
the surprising change in leadership will mean for a nation that has been
divided for some time. However, the shift in the balance of power has had a
constructive impact on our economic and earnings forecasts. We expect increased
potential growth, rising from 2.0-2.5% to 3% with greater productivity given
expected policies. Rising inflation will accelerate interest rate normalization.
The fiscal deficit can moderate with stronger growth. Investors seem to agree
given recent response of equities, bonds, and U.S. dollar.
- Corporate
and individual tax reforms, combined with targeted deregulation, are among top
priorities of Congress and the new Administration. Rolling back some portion of
nearly 500
Executive Orders
or
Memoranda
will have an impact by Spring 2017.
Loosely written legislation increased dependence on complex agency rulemaking
and interpretive guidance are subject to revision after transition. Thus, there
are many ways to affect policy change relatively quickly. Most politicians
tackle issues one at a time---we expect this Administration and Congress will
tackle many issues at once. Political status quo has been disrupted by
Ruthlessness
of Unruly Forces
, so be ready for substantial changes.
- Experience
suggests effects due to shifting balance-of-power usually lag significantly,
but consequences of this election are likely to have more immediate economic
impact. While actual policy changes are uncertain, change elections suggest an
implicit mandate and the direction is clear. Alignment of political control is
unusual, but can result in the greatest changes in the least time.
- Greater
infrastructure investment is likely but how it could be financed is widely
misunderstood. Should heavily indebted governments borrow to fund
infrastructure spending or let eager investors finance investment
opportunities? Alternative private external financing of infrastructure can
increase investment capacity at lower taxpayer cost. We can’t spend our way
into enhanced productivity any more than we can tax an indebted society into
prosperity.
- Global
interest rates are expected to rise, led by rate hikes in the United States.
Investors need to be vigilant about the impact on rate sensitive holdings, even
within private markets. Emergency monetary policy is no longer needed, so
investors must focus on the consequences of monetary normalization, including
winding down bond holdings. Expect steady ¼% interest rate hikes every other
FOMC meeting or 1% per year to at least 3.5%. Treasury 10-year bond yields need
to rise above 5%. A three decade long bond bull market led investors to adopt
unrealistic bond risk and correlation. Persistent losses should increase the
inflation risk premium.
- Our
global tactical asset allocation models favor overweighting U.S. equities with
a small-cap tilt, while underweighting U.S. and U.K. bonds. Resilient high
profit margins should support equities and drive earnings growth, while
interest rates normalize with a continued strong U.S. dollar. We are concerned
that low volatility and high dividend yield strategies could be vulnerable.
Financial and Industrial companies, including Defense, should benefit most in
this new regime. Currency and interest rate volatility should increase with
global economic divergences, but expect increased volatility-of-volatility for
equities. Secular and cyclical changes expected are significant for investors,
and we expect profound divergences across risk factors, while observing
evolution in risk measures, including volatility and correlation.
- We have identified various expected secular and cyclical investment conclusions resulting from the
Ruthlessness of Unruly Forces
. We exceeded our year-end S&P 500 target of 2150 in July, trading above and below this level in a relatively volatile trading range.
Economic Forecasts GDP Growth (Y/Y Real) S&P500 Earnings CPI Inflation (Y/Y) Unemployment Fiscal Deficit Fed Funds Target 10y Treasury Notes S&P 500 Target |
2012 2.3 6.0 1.8 7.8 -6.6 0.25 1.85 1426. |
2013 2.7 5.7 1.8 6.7 -3.2 0.25 3.00 1848. |
2014 2.5 8.1 0.7 5.6 -3.5 0.25 2.17 2059. |
2015 1.9 -0.9 0.7 5.0 -3.0 0.50 2.27 2044. |
2016e 2.1 1.3 1.7 4.9 -3.8 0.75 2.50 2150. |
2017e 2.5 10.9 2.5 4.8 -3.5 1.75 3.50 2350. |
2018e 2.7 13.6 2.7 4.5 -3.0 3.25 4.75 2500. |
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