david goerz
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.

Source: Strategic Frontier Management 


Loading PDF

More from david goerz
The most important insight of the day
Get the Harvest Daily Digest newsletter.