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Global Income Strategy
Portfolio and Economic Commentary – 1st Quarter 2017
Portfolio and Economic Commentary
1st Quarter 2017
GLOBAL INCOME STRATEGY COMMENTARY
Our investment philosophy is predicated on a timetested, three pronged approach providing solid risk
adjusted returns to our investors for over two decades.
• We believe in the importance of getting paid
immediately for the risks which are taken and focus on
businesses which compensate our clients with
dividends and above average interest. We believe
this income stream, coupled with capital appreciation, is
a vital aspect of total return.
• We dig deep for value often viewing crisis as an
opportunity. We believe that fundamental research and
patience are critical to long term success and that over
time, the price of a company will rise to reflect the
value of the underlying firm viewing each purchase as
if were buying a piece of a business – not simply a
stock certificate.
• We believe that global revenue generation is a key
component to growth and sustainability and invest in
companies with global growth opportunities. We are
unafraid to take contrarian positions, but remain
diligent about the risks of a global economy.
PERFORMANCE COMMENTARY
The Global Income strategy posted sound gains for the
quarter garnering a 3.25% return versus a gain of 3.81%
for the blended balanced benchmark. The annualized
trailing returns for the strategy since our inception on
January 1, 2003 are 7.06% versus 7.50% for the blended
benchmark and 6.38% for Morningstar’s US Fund
Allocation – 50% to 70% Equity. The twelve month
trailing yield for the Global Income strategy stands at
5.17% versus 1.71% for the Vanguard Balanced index
fund (VBINX).
We remain slightly underweight to a traditional 60%
stock/40% bond portfolio due to the risks which remain
and valuation metrics. That said, our portfolio maintains
a reasonable 18.49 P/E (TTM), and 13.7 forward P/E,
which is significantly lower than the broader market
indices – most of which currently maintain multiples in
excess of 20 times trailing earnings. Our focus continues
to emphasize the importance of immediate income to our
investors particularly in this volatile, low interest rate
environment, which we believe will persist for longer
than most economists. In the fixed income sector, our
emphasis remains on high yield bonds, which we believe
more adequately compensates our investors for credit risk,
while providing better protection in a potentially rising
interest rate environment. The following is an analysis of
the independent strategies which comprise our flagship
Global Income strategy in percentages indicated above.
Sector Allocation
2.0%
31.3%
Disciplined Alpha
Dividend
International ADR
Dividend Income
42.1%
24.6%
Unconstrained Fixed
Income
Cash
Top Five Equity Holdings
Weight
Apple
1.19%
Principal Financial
1.11%
JPMorgan Chase & Co.
1.07%
Qualcomm
1.07%
Cisco Systems
1.07%
Top Five Fixed Income Holdings
Weight
Blue Cube Spinco
0.60%
Icahn Enterprises
0.58%
The ADT Corporation
0.58%
Centurylink Inc
0.56%
Credit Acceptance Corp.
0.56%
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Portfolio and Economic Commentary
1st Quarter 2017
DISCIPLINED ALPHA DIVIDEND STRATEGY COMMENTARY
As value investors, we constantly focus on our duty to
protect the principal of our investments even as we look
for ways to grow them over time as well. As economists,
we remain alert to trends taking place in the larger
global economy. As analysts, we seek to invest in
securities priced with a margin of safety in order to
account for their near term volatility and our uncertainty
about what the future holds. With this in mind, we look
for opportunities in three specific categories: classic
value, persistent earners, and distressed or contrarian.
Classic value stocks sell at attractive valuations and
provide above-average dividend yields and growth.
Persistent earners are companies which have steady
and predictable earnings and that are selling below
their historic valuation. The distressed/contrarian
category refers to stocks that are out of favor due to
what we perceive to be temporary factors and are likely
to appreciate substantially as the temporarily
distressing factor recedes. Typically the distressed
category is the smallest in the portfolio.
PERFORMANCE COMMENTARY
The Disciplined Alpha Dividend strategy gained 2.14%
while the Russell 1000 Value index returned 3.27% for the
quarter. The strategy has produced outstanding ten-year risk
adjusted returns roundly besting its indices and peer group
for the period earning a Morningstar 4-star overall rating.
The trailing annualized ten year returns were 8.06% for the
strategy, 5.93% for the Russell 1000 Value index and 6.89%
for the Dow Jones US Select Dividend index.
Sector Allocation (Morningstar)
Though the strategy produced sound absolute returns, our
stock selection had a negative effect on relative
performance. Our sector allocation weighting also slightly
detracted from relative performance leading to a negative
active return against the Russell 1000 Value index for the
quarter. The technology, consumer defensive and financial
services sectors were our largest attributors to relative
outperformance, while the industrials, consumer cyclicals
and energy sectors were the largest detractors. Though
maintaining a focus on dividends and above average income
generation, we believe the utility and real estate sectors
remain overvalued and will perform poorly in a potentially
rising interest rate environment. The top performers for the
quarter were Apple (24.6%), Philip Morris (24.5%), KKR &
Co. (19.5%), Cisco Systems (12.8%) and Principal Financial
Group (9.9%). The bottom performers were Pitney Bowes
(-12.5%), New York Community Bancorp (-11.2%),
Occidental Petroleum (-10.0%), Marathon Oil (-8.4%) and
Exxon Mobil (-8.3).
20%
Financial Services
3%
Technology
6%
6%
26%
9%
Consumer Cyclical
Healthcare
Industrials
10%
19%
Consumer Defensive
Communication Services
Energy
Top Ten Holdings
Weight
Apple Inc
3.77%
Principal Financial
3.52%
JPMorgan Chase & Co.
3.40%
Qualcomm Inc
3.39%
Cisco Systems Inc
3.39%
International Business Machines
3.37%
Microsoft Corp
3.34%
Hanesbrands Inc
3.31%
MetLife
3.19%
Norfolk Southern Corp
3.19%
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Portfolio and Economic Commentary
1st Quarter 2017
DISCIPLINED ALPHA DIVIDEND STRATEGY COMMENTARY
As one may recognize from the below chart, our firm
has consistently provided a steady stream of income to
our clients in the form of dividends. It is our assertion
that this income stream has not only reduced the risk of
our portfolio, but also provided a large part of the total
return thereby leading to our performance success over
this past tumultuous decade plus.
We believe that dividends allow our investors to “get
paid to wait” while patiently working through volatile
business and market cycles. This strategy provides
emotional support during difficult cycles enabling
investors to weather turbulent periods utilizing
dividend income for personal needs or to reinvest cash
at lower valuations. Our strategy is not only grounded
in psychological and behavioral finance concepts, but
is also supported by empirical evidence outperforming
in both negative and full market cycles.
ALTRIUS:
Dividends also act to align the interests of corporations
and shareholders in helping to eliminate the agency
effect. Corporate boards have recognized the value of
dividends in stabilizing their stock price and
encouraging investment during both high and lower tax
regimes. In supporting and increasing dividends over
time, managers are compelled to maintain a reliable
stream of cash flows to shareholders rather than waste
capital on those expenses adding little to corporate
revenue including executive perks, pet projects, and illtimed, unwise acquisitions. It appears a paradox;
however, our experience and academic studies have
displayed that sufficient investment for a good business
can still occur in conjunction with dividends as
managers are forced to invest cash flow more prudently
and only in those capital investments in which they have
the highest conviction in adding to corporate revenue
particularly since stocks buybacks are often ill-timed.
THIRTEEN YEARS OF CONSISTENT DIVIDENDS
The strategy has consistently delivered a higher dividend yield than the S&P 500 since inception.
4.50%
Altrius DA
S&P 500
4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
Source: Standard and Poor's
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4
Portfolio and Economic Commentary
1st Quarter 2017
INTERNATIONAL ADR DIVIDEND INCOME STRATEGY COMMENTARY
As value investors, we constantly focus on our duty to
protect the principal of our investments even as we look
for ways to grow them over time as well. As economists,
we remain alert to trends taking place in the larger
global economy. As analysts, we seek to invest in
securities priced with a margin of safety in order to
account for their near term volatility and our uncertainty
about what the future holds. With this in mind, we look
for opportunities in three specific categories: classic
value, persistent earners, and distressed or contrarian.
Classic value stocks sell at attractive valuations and
provide above-average dividend yields and growth.
Persistent earners are companies which have steady
and predictable earnings and that are selling below
their historic valuation. The distressed/contrarian
category refers to stocks that are out of favor due to
what we perceive to be temporary factors and are likely
to appreciate substantially as the temporarily
distressing factor recedes. Typically the distressed
category is the smallest in the portfolio.
PERFORMANCE COMMENTARY
The International ADR Dividend Income strategy had both
positive absolute and relative performance returning 7.23%
for the quarter. The MSCI EAFE Value index was higher
by 6.05% while the S&P Int’l Dividend Opportunities index
gained 6.19%. Since its inception on June 1, 2010, the
strategy has produced annualized returns of 5.58% versus
4.04% for the S&P Int’l Dividend Opportunities and 6.28%
for the MSCI EAFE Value indices respectively. Since its
inception, the strategy has produced alpha against the MSCI
EAFE Value index due to its significantly lower beta.
Our sector allocations detracted from relative performance
while our stock selection had a positive impact during the
quarter versus the EAFE Value index. The consumer
defensive, communication services, healthcare and
industrials sectors attributed the greatest portion to relative
performance while energy, financial services and basic
materials were the largest detractors. Going forward, we
believe we will find more value amongst international issues
than U.S. companies while expecting the energy and basic
materials sectors to be continued benefactors of global
economic stabilization. The top performers for the quarter
were POSCO (22.7%), Unilever (22.0%), Telefonica
(21.6%), British American Tobacco (20.5%) and Banco
Santander (18.4%) while the bottom performers were
Transocean (-15.5%), Ensco (-7.8%), Toyota (-7.3%),
Aegon (-7.2%) and BP (-6.0%).
Sector Allocation (Morningstar)
Financial Services
4% 2%
Basic Materials
6%
Energy
9%
34%
Healthcare
Consumer Defensive
10%
Industrials
11%
11%
12%
Consumer Cyclical
Communication Services
Technology
Top Ten Holdings
Weight
Lloyds Banking Group
4.19%
HSBC Holdings
4.12%
Barclays
3.87%
Lazard LTD
2.64%
Posco
2.35%
Taiwan Semiconductor
2.30%
Siemens
2.29%
Banco Santander
2.29%
Daimler
2.20%
BNP Paribas
2.18%
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5
Portfolio and Economic Commentary
1st Quarter 2017
UNCONSTRAINED FIXED INCOME STRATEGY COMMENTARY
Based on our macroeconomic outlook over a three to
five year period and our cyclical views from quarter to
quarter, we employ top-down strategies that focus on
yield curve positioning, volatility, and sector rotation.
We then utilize bottom-up analysis to drive our security
selection process and facilitate the identification of
undervalued securities with the potential for above
average income. We invest in securities that operate
across diversified sectors in the fixed income markets of
the United States, primarily those in U.S. dollar
denominated high yield and investment grade bonds,
including government securities, corporate bonds, and
mortgage- and asset-backed. Sources of added value:
Credit Analysis - We emphasize independent analysis
and do not rely on credit agencies.
Duration Risk - We avoid long, extreme duration
shifts generally operating within a moderate duration
range typically between two and four years.
High Income - Our research attempts to identify issues
paying above average income.
Risk Premium Management - We seek to attain an
attractive yield/spread in relation to a five-year treasury
within acceptable levels of portfolio risk.
PERFORMANCE COMMENTARY
Sector Allocation
MARKET OVERVIEW
The fixed income markets got off to a strong start in
2017, with almost all market segments ending the first
quarter of the year in positive territory. Building upon
trends established in 2016, high yield corporate bonds
continued to be the best performing taxable fixed
income market segment, with the Barclays Capital US
Corporate High Yield index producing a return of 2.70%
for the first quarter of 2017, thoroughly outpacing
investment grade corporate bonds which returned 1.22%
(Barclays Capital US Corporate Investment Grade
index). Longer dated US treasury bonds outperformed
their shorter dated counter parts, with the 30-year
Treasury returning 1.30% for the quarter, slightly
outpacing TIPS which returned 1.26%. The 10-year
Treasury note, which started the year off yielding
2.45%, closed out the quarter yielding 2.40%, but not
before having sold off in early March to a yield of
approximately 2.60%. In its March meeting, the Federal
Reserve raised its benchmark interest rate a quarter
point, moving the overnight funds rate to a target range
of 0.75% to 1.00%. Spreads on corporate bonds, both
investment grade and high yield, continued to contract to
below long-term historical averages during the first
quarter of 2017, with the Bank of America Merrill
Lynch High Yield Option-Adjusted Spread falling from
5%
4%
Consumer Discretionary
Energy
1%
3% 2%
Financials
Industrials
22%
Materials
5%
Consumer Staples
5%
Services
15%
11%
Health Care
Telecommunications Services
Information Technology
13%
14%
Cash
Utilities
Top Ten Holdings
Weight
Blue Cube Spinco Inc
1.41%
Icahn Enterprises LP
1.37%
The ADT Corp
1.36%
GAP Inc
1.32%
Anglogold Ashanti Holdings
1.32%
Credit Acceptance Corp
1.31%
Centurylink Inc
1.31%
American Axle & Manufacturing
1.29%
Dish Network Corp
1.24%
Rent A Center Inc
1.23%
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Portfolio and Economic Commentary
1st Quarter 2017
UNCONSTRAINED FIXED INCOME STRATEGY COMMENTARY
a level of 422bps as of December 30, 2016 to 392bps by
quarter end, 189bps below its 20-year historical average of
581bps. The yield curve also flattened out by quarter end,
with the slope of the ‘belly of the curve’, the differential
between the 2-year and 10-year treasury notes, ending the
quarter at 113bps.
15% respectively. It should be noted that the strategy’s
exposure to the energy sector declined substantially during
the first quarter of 2017 from levels consistently
maintained in prior years of between 17% and 20%;
contracting over 4.0% from the most recent quarter end
December 30, 2016. This decline in sector exposure is
predominantly the result of increased call activity of energy
and energy related companies held within the strategy over
US Treasury Yield Curve
the first three months of the year, and the scarcity of
4.0%
compelling new issues currently available in the energy
3.0%
sector possessing ‘shorter durations’ and stable credit
2.0%
metrics.
The strategy’s exposure to the financial,
industrial, and materials sectors remained relatively robust
1.0%
with each sector accounting for approximately 14%, 13%,
0.0%
1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 20 yr 30 yr and 11% respectively of aggregate strategy assets. Health
care, with the exception of energy, was the only sector that
experienced a notable change in exposure, increasing from
1 Yr Ago
As of March 31, 2017
previous levels of approximately 3% to just under 5%. The
PERFORMANCE SUMMARY
increase in the strategy’s exposure to health care was
The Unconstrained Fixed Income strategy generated a largely a result of the establishment of a couple new
gross return of 2.11% for the first quarter of 2017, positions in companies directly involved in the running of
underperforming the Bank of America Merrill Lynch High preventative care and specialized health care facilities, as
Yield index on an absolute basis by 60bps, but well as the previously mentioned price recoveries in a
outperforming the Barclays US Aggregate Bond index by number of the strategy’s long standing health care related
129bps. A number of the strategy’s previously distressed holdings.
issues experienced substantial price recoveries during the Despite establishing new positions in a number of ‘BB’
first quarter of 2017, helping to boost aggregate returns of companies, the strategy’s aggregate credit rating remained
the strategy as a whole. Health care, which started to sell- unchanged at ‘B’. The distribution of the strategy’s assets
off in December 2016, rebounded substantially in the latter ratings is provided in the exhibit below.
half of the quarter on news that the Trump administration
Credit Rating Distribution
was unsuccessful in replacing and/or making alterations to
50%
current health care policy, which led to health care
42%
becoming the strategy’s best performing sector for the first
40%
34%
quarter of 2017.
30%
STRATEGY CHARACTERISTICS
20%
Consumer discretionary and energy remain the strategy’s
two most heavily invested sectors with aggregate exposure
to each closing out the quarter at approximately 22% and
10%
15%
6%
1%
2%
CC - D
N/R
0%
BBB
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BB
B
CCC
7
Portfolio and Economic Commentary
1st Quarter 2017
UNCONSTRAINED FIXED INCOME STRATEGY COMMENTARY
Both the aggregate maturity and effective duration for the
strategy expanded marginally from prior levels ending the
quarter at 3.46 years and 2.90 respectively. The majority
of new issues established during the quarter are callable at
various dates prior to their individual designated maturity
dates; however, the strategy’s longest dated ‘non-callable’
issue is currently set to mature in December of 2023.
Maturity Distribution
50%
44%
41%
40%
reported US unemployment rates forecasted to remain
under 5.0%. Given the strengthening and perceived
stability of the US economy, and persistently low rates
globally, US corporate bonds, both investment grade and
high yield, will likely continue to build upon the most
recent quarter(s) gains, with periods of intermittent
volatility likely to occur. Valuations in both the investment
grade and high yield corporate bond markets are currently
at levels near long-term historic highs as evidenced by
option-adjusted spreads relative to similar dated US
treasury securities, with high yield currently at 392bps,
189bps below its 20-year historical average of 581bps.
30%
20%
10%
9%
6%
2500
BofA Merrill Lynch US High Yield OptionAdjusted Spread
2000
0%
< 1 Year
1 - 3 Years
3 - 5 Years
5 - 7 Years
STRATEGY OUTLOOK
20-year Median Spread = 522bps
1500
HY OA Spread
= 392bps
as of 3/31/2017
20-year Avg. Spread = 581bps
1000
We entered 2017 cautiously optimistic following 2016’s
exceptional year of performance, wherein the
Unconstrained Fixed Income Strategy produced a total
return for the year of 22.08% (gross of fees), which even
outpaced the greater high yield market by approximately
500bps. In the final newsletter of 2016 we set forth an
‘optimistic’ total return expectation for the high yield
market to generate a more modest annual total return for
2017 in the low to mid-single digits. Although very much
welcomed, we did not anticipate such a strong start to the
year, and with the greater high yield market already
returning 2.88% for the first quarter of 2017, we remain
cautiously optimistic concerning the stability of the fixed
income markets going forward. Although broad market
consensus is anticipating the likelihood of multiple rate
increases by the Fed over the course of the year, our
inflation expectations are a little more subdued given oil
prices will likely remain range bound between $50/bbl and
$60/bbl and wage increases should remain modest keeping
the inflation rate around the Fed’s 2.0% target rate, despite
500
0
Despite such rich valuations, and in the face of high levels
of call activity requiring the persistent replacement of
existing issues, we are continuing to find numerous
compelling investment opportunities across an array of
sectors. We have continued to extend the maturity window
on new investments slightly, going as far out as 2023,
which has had little affect on the strategy’s aggregate
duration, which at 2.90 is less than half that of the
aggregate high yield market. In closing, we still believe
that high yield corporate bonds are attractive and remain
the best risk/reward tradeoff opportunity in the fixed
income markets for providing above average income and
mitigating the affects of future interest rate increases.
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8
Portfolio and Economic Commentary
1st Quarter 2017
MARKET AND ECONOMIC OUTLOOK
Market Review
Global equities greeted the new year with the same
degree of élan with which they closed 2016. Developed
international stocks led the way with U.S. stocks closely
behind as the Vanguard FTSE Developed International
ETF was higher by 8% and Vanguard 500 Index up 6%
respectively. Investor optimism remained high with the
VIX (the markets’ fear gauge) ending the quarter at
historic lows. Macroeconomic fundamentals were also
broadly supportive of the continued rally for equities.
Investors took the Federal Reserve’s widely anticipated
0.25% increase in the federal funds rate in stride,
treating it as another indicator of the U.S. economy’s
return to form. As Fed Chair Janet Yellen stated, “The
simple message is the economy is doing well.” The
Bureau of Economic Analysis released a revised GDP
figure of 2.1% for the fourth quarter of 2016 versus an
earlier estimate of 1.9%.
In Europe, stock gains also seemed to reflect a
combination of bullish investor sentiment and positive
economic data, including rising corporate earnings.
Defensive assets turned in a decent performance during
the first quarter. Treasuries rallied after the Fed’s March
15th announcement with the core bond index making up
some ground in the latter half of March versus its
performance in January and February. Core bonds
finished the quarter with a 0.9% return (Vanguard Total
Bond Market Index).
Moves in Treasuries and the U.S. dollar were closely
tied to investor perceptions that the Fed might be poised
to take a more hawkish stance on interest rates in
anticipation of Trump’s legislative agenda boosting
inflation. This view changed as the quarter drew to a
close, with both the Fed and financial markets
forecasting roughly two more rate hikes this year. The
yield on the 10-year Treasury ended March at 2.4%,
down from an intra-quarter high of 2.6%. The dollar also
fell, ending 2.8% lower against a basket of currencies.
Currency traders attributed the fall to the Fed’s failure
to raise its inflation expectations, which would signal a
potential move to a more accelerated pace of interest
rate increases.
It’s too soon to know how the second quarter will play
out, but we remain alert to potentially policy-driven
political risk in the United States. In Europe, the
outcome of upcoming elections, and related
developments in France (May) and Germany
(September), may have unexpected impacts on markets.
While to date investors have shown a remarkable degree
of staying power, that does not mean they will continue
to do so.
Economic Outlook
For the first time in a while, global economic growth is
in sync and improving. A quick survey of the economic
landscape suggests the environment should remain
supportive of stocks and other risk assets, at least over
the next six to 12 months or so. As we’ll discuss later,
we continue to believe high current valuations may be a
headwind to U.S. stock market returns. We also remain
concerned about the unresolved risks stemming from
the global debt build-up and unprecedented central bank
policies. However, for the time being at least, the global
macroeconomic backdrop offers reason for optimism
that many of the reflationary trends that have benefited
our portfolios in recent quarters can continue.
Across a wide range of measures, the global economy is
in its best shape in many years. Economic growth in
most countries and industries has been accelerating,
albeit modestly, with leading economic indicators
suggesting the trend can continue. We expect world
GDP growth to be at least 3% this year, up from 2.5%
in 2016. In its March 16th cover article titled, “On the
Up: The World Economy’s Surprising Rise,” The
Economist noted that across the United States, Europe,
Asia, and emerging markets, “all the burners are firing
at once, for the first time since a brief rebound in 2010.”
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Portfolio and Economic Commentary
1st Quarter 2017
MARKET AND ECONOMIC OUTLOOK CONT.
While unexpected macro shocks can occur at any time,
causing at least a short-term flight from risk assets, the
likelihood of an incipient U.S. or global economic
recession appears low. Without a recession, history
suggests a bear market in stocks is unlikely.
• The widely followed Global Manufacturing
Purchasing Managers Index (PMI) just hit its highest
level since May 2011. The Eurozone Manufacturing
PMI is also at its highest level since April 2011;
while China’s PMI is at its highest since January
2013. As shown in the chart below from BCA, the
Global Manufacturing PMI and global equity returns
have been correlated over time.
• BCA’s “Global Leading Economic Indicator”
registered its 10th straight monthly increase and
highest level since January 2014.
are meant to capture whether and to what extent new
economic data points are exceeding or disappointing
consensus expectations. As the chart below indicates,
these indexes have also rebounded sharply over the past
year. In fact, the Surprise indexes for Europe and
emerging markets both recently hit seven-year highs.
• Ned Davis Research’s Global Recession Probability
model recently dropped into the Low Recession Risk
zone.
Macroeconomic fundamentals appear reasonably solid
and are improving from cyclically depressed levels in
many regions outside the United States. However,
financial markets respond to new data, information, and
events that differ from the consensus expectations
already discounted in prices. In other words, markets
react to surprises. The Citi Economic Surprise Indexes
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10
Portfolio and Economic Commentary
1st Quarter 2017
MARKET AND ECONOMIC OUTLOOK CONT.
Portfolio Positioning and Outlook
U.S. Stocks
In our 2016 year-end commentary, we noted that on the
heels of a fourth straight year of underperformance for
foreign stocks versus U.S. stocks, the consensus view
was for more of the same this year. The consensus was
also for the U.S. dollar to appreciate, driven by
divergent central bank policies—with the U.S. raising
rates while other major central banks continued
monetary stimulus—as well as President Trump’s
expected fiscal and trade policies. Both these consensus
views have been wrong so far this year. International
stocks have outpaced U.S. stocks, and the dollar has
declined by about 3%, retracing much of its postelection gain. (The dollar still looks overvalued based on
longer-term fundamentals.) These counter consensus
reversals were helpful to our portfolios in the first
quarter, given our current strong weighting toward
international stocks.
Over the longer term, our analysis continues to indicate
the U.S. stock market is somewhat overvalued – though
our predilection toward value securities has kept our
U.S. stocks at historically reasonable levels for equities.
In contrast, many growth stocks are selling at
spectacular multiples which we believe are
unsustainable. Specifically, our base case estimate of
the expected annualized total return for broad U.S.
market indices (which include growth stocks) is in the
low single digits over the next five years. For U.S.
stocks to be priced in what we consider to be a “fair
value” range (that is, to at a minimum compensate
investors for the risks they incur owning public
equities), their expected return would need to be at least
in the upper single digits. Since we are well below that
hurdle rate in our base case scenario, we remain less
than fully invested in U.S. stocks.
As the valuation chart to the top right indicates, the U.S.
stock market is as expensive as it has ever been in the
past 50 years, with one exception: the dot-com stock
market bubble of the late 1990s, from which the S&P
500 Index plunged nearly 50%. When stock market
valuations are high, the odds are your future market
returns will be low. Thus, we remain underweight to
U.S. equities in favor of (1) foreign stocks with much
better return prospects, (2) select, less expensive and
attractively priced companies which we believe are
valued at more reasonable multiples and offer above
average dividends to reduce risk (as measured by
standard deviation and beta) and provide greater longterm total return and (3) high yield bonds which may
offer equity like returns with greater income and
generally less volatility than stocks.
European Stocks
Our portfolios have meaningful exposure to developed
international markets with a strong weighting in
European stocks. These positions added value to our
portfolios in the first quarter and we continue to be
confident European stocks will outperform their U.S.
counterparts over the next several years.
Primarily due to the onset of a regional debt crisis in
2011, European corporate earnings have barely grown
since the 2008–2009 financial crisis. Fiscal and
monetary policies have not been stimulative enough to
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11
Portfolio and Economic Commentary
1st Quarter 2017
MARKET AND ECONOMIC OUTLOOK CONT.
to offset this. Meanwhile, U.S. company earnings have
grown strongly, exceeding prior cyclical highs due to
historically high profit margins, stock buybacks, and low
interest expenses. This divergence in earnings trends is
the key reason we view European stocks as more
attractive looking forward.
We estimate that over the next five years European
companies will likely grow earnings at a much faster
rate than their U.S. counterparts which would lead to
outperformance by European stocks. Simply stated, we
believe European earnings are cyclically depressed,
while U.S. earnings are near cyclical highs. Further, we
do not believe this condition is adequately reflected in
their respective valuations. We don’t know the precise
timing or exactly what catalyst will lead investors to
close the gap. This is especially true now, when political
uncertainty in Europe is high. Yet, there are reasons for
optimism the market will finally start to take notice.
Last year, for the first time since the 2008–2009
financial crisis, Europe’s economy grew faster than that
of the United States. Improving economic growth is a
good sign as it ultimately leads to better sales growth
and invites consumers and corporations to borrow and
spend, furthering the growth cycle. This is illustrated
below, as private sector credit growth in Europe is up at
the fastest rate since the financial crisis.
Unsurprisingly, the European Central Bank is expressing
greater confidence in its economic outlook, and has
revised upward both its inflation and growth projections
for 2017–2018. We are also finally seeing better
earnings from European companies. Looking at the
sector level, the most beaten down sectors, such as
financials and energy, are seeing the fastest earnings
growth year over year in local-currency terms. Europe
has a relatively large exposure to these sectors and any
improvement there will reflect positively in index-level
earnings growth.
Last but not least, we own many global business
franchises that while domiciled in Europe are geared
toward growth outside the continent. Even if Europe’s
growth were to disappoint, these businesses would
benefit from emerging markets’ growth and/or
improvement in the United States’ economy.
Fixed-Income
For the quarter as a whole, our high yield positions well
outperformed core bonds continuing the trend from
2016. Our fixed-income exposure encompasses what we
believe is a prudent amount of credit risk and modest
interest-rate risk (duration). It also offers a meaningful
yield and expected-return advantage versus the core
bond index. We continue to believe that over the next
several years the most likely direction for U.S. interest
rates is higher, although it will likely be a bumpy path.
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Portfolio and Economic Commentary
1st Quarter 2017
MARKET AND ECONOMIC OUTLOOK CONT.
Conclusion
That would be consistent with the evidence of global
economic reflation as discussed previously. In such a
scenario, core bond index annualized returns will be
extremely low (and potentially negative over a 12-month
period). In contrast, we believe our actively managed,
unconstrained and opportunistic approach can generate
mid-single-digit-type annualized returns.
Despite a high level of volatility emanating from U.S.
politics in recent months, U.S. stock market volatility has
remained very low. That is unlikely to last. We remain
confident in our positioning and in our investment
process, both of which allow us to look past periods of
uncertainty and keep our focus where it should be: on
prudently managing our diversified portfolios to achieve
long-term, risk-adjusted returns.
As always, we appreciate your confidence. Please do not
hesitate to contact us with any questions.
www.altriuscapital.com
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Portfolio and Economic Commentary
1st Quarter 2017
DISCLOSURES
This report includes candid statements and observations regarding investment strategies, individual securities, and
economic and market conditions; however, there is no guarantee that these statements, opinions or forecasts will
prove to be correct. These comments may also include the expression of opinions that are speculative in nature and
should not be relied on as statements of fact. Altrius is committed to communicating with our investment partners as
candidly as possible because we believe our investors benefit from understanding our investment philosophy and
approach. Our views and opinions include “forward-looking statements” which may or may not be accurate over the
long term. Forward-looking statements can be identified by words like “believe,” “expect,” “anticipate,” or similar
expressions. You should not place undue reliance on forward-looking statements, which are current as of the date of
this report. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new
information, future events or otherwise. While we believe we have a reasonable basis for our appraisals and we have
confidence in our opinions, actual results may differ materially from those we anticipate.
The information provided in this material should not be considered a recommendation to buy, sell or hold any
particular security. The S&P 500® Index is an unmanaged index of 500 selected common stocks, most of which are
listed on the New York Stock Exchange. The Index is adjusted for dividends, weighted towards stocks with large
market capitalizations and represents approximately two-thirds of the total market value of all domestic common
stocks. The Russell 1000 Value Index is an unmanaged index commonly used as a benchmark to measure value
manager performance and characteristics. The Dow Jones U.S. Select Dividend Index is an unmanaged index
commonly used as a benchmark to measure dividend manager performance and characteristics. The Russell 2000
Index, the Russell 2000 Growth Index, and the Russell 2000 Value Index are unmanaged indices commonly used as
benchmarks to measure small cap manager performance and characteristics. The MSCI EAFE® Index is a free floatadjusted market capitalization index that is designed to measure developed market equity performance, excluding the
U.S. & Canada. The Barclays Capital U.S. Aggregate Bond Index and Bank of America Merrill Lynch US High
Yield Master II Total Return Index are unmanaged indices that are commonly used as benchmarks to measure fixed
income performance and characteristics. Index performance returns do not reflect any management fees, transaction
costs or expenses. Investments cannot be made directly in an index. Investments made with Altrius Capital
Management, Inc. are not deposits or obligations of any bank, are not guaranteed by any bank, are not
insured by the FDIC or any other agency, and involve investment risks, including possible loss of the
principal amount invested. Past performance is not a guarantee of future returns.
Certain material in this work is proprietary to and copyrighted by Litman Gregory Analytics and is used by Altrius
Capital with permission. Reproduction or distribution of this material is prohibited and all rights are reserved.
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