Download Quarterly Review - Q1 - Boston Advisors, LLC

Quarterly Market Review
Q1 2017
Michael J. Vogelzang, CFA
President &
Chief Investment Officer
Eric Eaton, CFA
Portfolio Manager &
Allocation Analyst
Boston Advisors, LLC – One Liberty Square, 10th floor- Boston, MA 02109 | p. 617.348.3100 | www.bostonadvisors.com
Boston Advisors Quarterly Market Review | 2017 First Quarter
First Quarter 2017 Review
The U.S. stock market started the year like gangbusters. After a strong rally through January and
February, prices eased off somewhat and finished lower for the month of March. Once the dust
settled, the S&P 500 gained an impressive 5.5% for the quarter. International equity indices rallied
even more as emerging markets powered up 11.5%, followed closely by developed international
bourses rising 7.3% on the quarter.
Source: Bloomberg
Performance Contributors



Overweight U.S. Large Cap Growth – Large Cap Growth stocks led the U.S. market higher,
moving up 8.8%. After lagging the broader market in 2016, this was a welcome development.
With as much as 45-50% of your portfolios invested in this slice of the U.S. market, this was
the single largest contributor to a strong quarter.
Allocation to Emerging Market Stocks – Emerging market stocks were the best performing
asset class this quarter, as economic growth prospects increased with the global outlook,
China’s outlook stabilized and investors continue to hunt for value.
Developed International Equity – Our recent addition of International Developed equity to the
portfolios is off to a good start. As interest rates remain low in Europe and Japan, economic
and profit growth has accelerated. We continue to believe this combination, along with lower
valuations than the U.S. market, will provide some durability to this rally.
Page | 1
Boston Advisors Quarterly Market Review | 2017 First Quarter
Performance Detractors


Cash – Even a modest amount of cash reserves in a rising market weighs on performance.
We strive to keep a small allocation to cash in a rising market and a larger allocation in a
falling market. Cash provides a great level of “optionality” to the portfolio – that is, having cash
not only reduces risk for unexpected downward volatility in markets, but provides dry powder
to take advantage of lower prices should they come along.
Fixed Income – While fixed income securities didn’t detract from performance, they didn’t help
much either. Fixed income still maintains an important position in a globally diversified asset
allocation portfolio for the income produced and diversification.
During the quarter, several broad themes impacted markets, including U.S. politics, rising interest
rates in the U.S., politics in Europe, the strength/weakness of the U.S. dollar, an expanding global
economy and strong international equity markets. We see these themes continuing to play out as
2017 progresses.
U.S. Politics: Healthcare, Tax Reform, Infrastructure
With the vote to repeal and replace the Affordable Care Act seemingly permanently postponed, many
are left wondering about the degree to which Trump can work with his own party. While not meant as
an espousal of a political position, the current administration has clearly gotten off to a rocky start in
terms of leadership. The Freedom Caucus, made up of the most conservative Republicans, has dug
in its heels on issues like healthcare and continues to cause a split in the party. Polarization between
Republicans and Democrats at almost every level compounds the political tension, creating
dysfunction and lack of progress on many key issues faced by the country—and as it relates to the
markets—the economy.
The graph to the right shows recent polling
data taken by NBC on Trump’s job
approval ratings. The results indicate that
the President’s approval has decreased,
which could further impact his credibility
and ability to get things done. However, he
has a reputation as a good dealmaker and
many believe that with a bit more political
experience under his belt, deals will start
to happen in D.C.
As mentioned, we saw some softness in
the U.S. equity market in March. Investor
consensus remains that Trump can still
make significant progress towards his goals of infrastructure spending, tax reform, and increased jobs
Page | 2
Boston Advisors Quarterly Market Review | 2017 First Quarter
for Americans – just that it will take a bit longer due to the political turmoil. Depending on this timing, a
modest pullback in the market makes sense as these economic stimuli would arrive later. Regardless,
the U.S. economy remains strong with solid and improving earnings growth, high and growing
employment, and a positive outlook for the remainder of the year.
U.S. Interest Rates: A Rising Rate Environment
At the beginning of the year, the Federal Reserve (the Fed) expected to increase its benchmark
interest rate three times during 2017. The first increase is now behind us (in mid-March), leaving two
more potential rate increases on the table for the next nine months. The Federal Funds Futures
market currently prices in a very low probability of a rate hike in May but expects a 56% chance of an
increase in June. That probability jumps to 73% by September.
This graph of the Fed’s famous “dot plot” gives an idea of what the Fed members expect as of their
recent March meeting. Each dot represents the opinion of one voting member of the committee. It
shows that in 2017, nine
members believe the Fed’s
benchmark rate will end up
between 1.25% and 1.50%, and
one member believes it will end
up between 1.0% and 1.25%,
etc. (today it remains between
0.75% and 1.0%). Also, the Fed
just released the notes from its
March meeting, indicating that it
will mostly likely start shrinking its
balance sheet later this year –
another way to reduce liquidity in
the economy. The big takeaway
is the expectation that rates will
rise over the next few years. An
expectation held not only by the
market, but by the officials setting
those rates.
Rising interest rates endure as a negative catalyst for the prices of bonds already held by investors.
As interest rates rise, investors would rather hold newly issued bonds with higher interest rates.
Therefore, they sell their older bonds with lower rates to buy the newer ones with higher rates. Our
purchases in late 2016 of the SPDR Bloomberg Barclays Investment Grade Floating Rate ETF
(FLRN) and the PowerShares Senior Loan Portfolio ETF (BKLN) have done what we intended them
to do. They provide an income stream while keeping prices stable while interest rates rise, rather than
decreasing in price like traditional bonds.
Page | 3
Boston Advisors Quarterly Market Review | 2017 First Quarter
International and Emerging Equities: Returning Growth Continues
Non-U.S. stock markets rallied this past quarter, continuing to show signs of reversing multi-year
weak price performance. The big draw for investors? Cheap(er) companies and increasing growth
prospects. Valuations of companies in International Developed markets (particularly Europe) and
Emerging Markets remain significantly lower than companies in the U.S. – a relative bargain.
However, these other markets do come with risks that we continue to watch closely.
While emerging market equities took the crown for the best performing asset class in the first quarter,
the risk here remains a strong U.S. economy/dollar. If the U.S. economy heats up, it motivates
investors to move money from emerging market investments to U.S. investments. Ironically, a strong
U.S. economy with good prospects for investment (both fixed income and equity) siphons money
away from international investing, driving down the emerging currencies. The irony is that stronger
U.S. economic vibrancy also provides the “engine” for stronger emerging economies, setting up
excellent opportunity. Your portfolios currently have modest emerging market equity exposure. For
now the risks seem to balance the rewards, but our bias remains to increase exposure at some point,
perhaps later this year.
The biggest risk in Europe continues to be political, as populism could gain ground, creating pressure
on the common currency Euro region. While real – we have certainly seen examples of surprising
election outcomes over the last year – we
think this risk has gotten a bit overblown,
particularly as the European economies
begin to strengthen. Populism is
catalyzed by weak economic conditions.
With growth, there is less
disenfranchisement and hence lessened
appeal to populism. For example, we saw
the populist candidate fail in the
Netherlands several weeks ago. Although
Marine Le Pen, the leader of France’s
Populist Party, made it through round one
of France’s presidential election, opinion
polls expect her to lose badly to
Emmanuel Macron in round two.
However, Italy is the largest concern for
investors.
Political or populism risk has the largest
toehold in Italy. The chart to the right
shows the so-called “Euroskeptic” parties
polling strongly there. Furthermore, the
number of Italians that stand opposed to
Page | 4
Boston Advisors Quarterly Market Review | 2017 First Quarter
the Euro currency has grown while many Italians remain confident in the prosperity of an Italian state
outside of the EU. This risk remains muted for now, as the earliest Italian elections would happen is
this fall, but more likely in May of 2018.
Conclusion
As always, investment implications for a global portfolio are as varied as the globe. The outlined
themes are ones that we see continuing to drive market action for now. With that said, we will
continue to monitor Europe with the thinking that the political situation will quiet, and continue to
assess the political situation versus growth prospects and the strength of our own economy. As we
have written often, our main job is as risk managers with an eye to carefully complement risk
management with opportunity. Risks are aplenty in today’s world – we continue to watch, remain
vigilant and be on the lookout for true opportunity.
As always, we welcome any questions or comments you may have.
Boston Advisors, LLC
ELF 2017-095
Page | 5