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.
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.