2017 Q1 Investment Report Commentary
Market Update: Hope and Fear Spring Eternal
Since the election, a tightly wound balance between investor hope and fear has driven markets. Market valuations are influenced by a combination of fundamentals and investor sentiment. When emotions overshoot fundamentals, that’s when opportunity, or risk, can emerge. The first quarter opened with post-election momentum continuing to propel US markets to new highs, but the pace tempered late in the quarter with the realization that implementing President Trump’s pro-growth agenda would face potentially significant obstacles. The release of less-robust-than-expected economic data compounded this slowdown. Nonetheless, positive investor sentiment, the so-called “soft data,” continued to buoy the market overall.
As optimism subsides and uncertainty about the future influences markets again, the need for a diversified portfolio remains paramount. Potential market outcomes abound, particularly for US equities, which currently trade at high valuations reflective of policy changes that may not actually occur. Investors therefore need carefully blended portfolios that are resilient in corrections but positioned for upside participation should pro-growth policies materialize. Daintree client portfolios, with their balance of stocks, bonds, real assets, and alternatives, are designed for these times of uncertainty, attempting to capture positive equity market returns and protect against losses in downturns. Notwithstanding resurgent fears of slowing growth, we remain cautiously optimistic, and our tactical portfolio allocations reflect this positive view.
For the first time since the global economy troughed in 2009, we may be witnessing a globally synchronized recovery, as the chart below illustrates. The US has produced the most sustained post-crisis recovery, and domestic returns reflect this growth. However, Emerging Markets and European economies appear to have turned the corner to increased growth. Their more attractive valuations relative to the US merit a higher than normal allocation, which is reflected in the positioning of most client portfolios. Ultimately, this optimism could prove misplaced, but the methodology is instructive: our portfolios avoid a spring-fevered race to one market, remaining globally diversified and thus better equipped to weather uncertain conditions.
Highlights for the quarter by asset class include:
Emerging Markets (EM) shot out of the gate as the best performing subsector, up over 11% as EM economic data continued to improve and foreign exchange and US policy headwinds abated.
Developed markets also posted strong absolute returns, with the US, Europe, and Asia up between 6.0 and 7.5%.
Overall, global equity markets were the big winner of the quarter. Daintree’s worst performing equity subsector, Hedged Equity, still returned a robust 2.7%.
As an asset class, Alternatives returned a modest 1.6%. However, Daintree’s manager selections did not beat the benchmark.
In the current low volatility markets, we do not expect alternatives to achieve high absolute returns, as many of these strategies rely on volatile asset prices to generate their best risk-adjusted results.
Real Assets performed well, with Daintree portfolios generally experiencing 2 to 3% return. Only one subsector detracted from overall returns.
Commodities ended the quarter down approximately 2%. This was mainly due to energy sector woes: after oil prices rebounded following OPEC’s production cuts, US producers increased output, causing prices to fall.
Global political uncertainty fueled a renewed demand for gold, which finished the quarter up 7.3%.
Despite entering a rising interest rate environment in the US, non-US REITs returned about 7%. While rising interest rates tend to negatively impact REITs in the short term by increasing borrowing costs, global monetary policy remains supportive of this capital-intensive subsector.
Seven of Daintree’s nine preferred managers beat their Daintree benchmark. On average, Daintree’s preferred managers outperformed by 0.9%, with the best manager outperforming by 4%.
While both sectors were positive on the quarter, Non-Core Fixed Income continued to outperform Core Fixed Income, as the former benefited from higher yields in a flattish interest rate environment.
Non-US/EM posted the strongest return, followed by High Yield. Inflation-Protected Securities and Bank Loan/Floating Rate funds also saw good returns on the quarter, as inflation moved higher together with the federal funds rate.
What’s on Our Radar?
We are monitoring valuations as usual and keeping an eye on two separate market drivers: global economic health, which includes market valuations, and political developments. Trends across economies and geographies seem favorable, and measures of economic sentiment are strong. The so-called “hard data,” such as GDP, wage, and productivity growth has lagged behind this sentiment, prompting a need for the hard data to catch up with the soft data to support current market valuations. On the political front, we continue to assess the likelihood of policy changes, particularly lower corporate tax rates and tariffs, mindful of the impact any changes might have on valuations. Of these two potential drivers, tax reform is currently more important to markets, as US stocks have already priced in lower taxes and increased earnings. Beyond the US, the potential for continued populist electoral victories, and the disruption to globalism any victories may cause, remains the subject of some concern.
The year is off to a relatively strong start, but we continue to monitor the tensions between investor hopes and fears. Daintree portfolios continue to adhere to our philosophy of seeking returns that appropriately compensate our clients for the risks involved.
Print Version – 2017 Q1 Investment Report Commentary
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