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helmstargroup.com
Economic Outlook
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Sailing with the Tides
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Embarking on a financial plan is like sailing around the world.
The voyage won’t always go to plan, and there’ll be rough seas.
But the odds of reaching your destination increase greatly
if you are prepared, flexible, patient, and well -advised.
A mistake many inexperienced sailors make is not having a plan at all.
They embark without a clear sense of their destination. And once they do
decide, they often find themselves lost at sea in the wrong boat with
inadequate provisions.
Likewise, in planning an investment journey, you need to decide on your
goal. A first step might be to consider whether the goal is realistic and
achievable. For instance, while you may long to retire in the south of
France, you may not be prepared to sacrifice your needs today to satisfy
that distant desire.
Once you are set on a realistic destination, you need to ensure you have
the right portfolio to get you there. Have you planned for multiple
contingencies? What degree of “bad weather” can your plan withstand
along the way?
Key to a successful voyage is a good navigator. A trusted advisor is like
that, regularly taking coordinates and making adjustments, if necessary. If
your circumstances change, the advisor may suggest you replot your
course.
As with the weather at sea, markets can be unpredictable. A sudden
squall can whip up waves of volatility, tides can shift, and strong currents
can threaten to blow you off course. Like a seasoned sailor, an
experienced advisor will work with the conditions.
Once the storm passes, you can pick up speed again. Just as a sturdy
vessel will help you withstand most conditions at sea, a well-diversified
portfolio can act as a bulwark against the sometimes tempestuous
conditions in markets.
Circumnavigating the globe is not exciting every day. Patience is required
with local customs and paperwork as you pull into different ports. Likewise,
a lack of attention to costs and taxes is the enemy of many a long-term
financial plan.
Distractions can also send investors, like sailors, off course. In the face of
“hot” investment trends, it takes discipline not to veer from your chosen
plan. Like the sirens of Greek mythology, media pundits can also be
diverting, tempting you to change tack and act on news that is already
priced in to markets.
A lack of flexibility is another impediment to a successful investment
journey.
If it doesn’t look as though you’ll make your destination in time, you may
have to extend your voyage, take a different route to get there, or even
moderate your goal.
The important point is that you become comfortable with the idea that
uncertainty is inherent to the investment journey, just as it is with any sea
voyage. That is why preparation and planning are so critical. While you
can’t control every outcome, you can be prepared for the range of
possibilities and understand that you have clear choices if things don’t go
according to plan.
If you can’t live with the volatility, you can change your plan. If the goal
looks unachievable, you can lower your sights. If it doesn’t look as if you’ll
arrive on time, you can extend your journey.
Of course, not everyone’s journey is the same. Neither is everyone’s
destination. We take different routes to different places, and we meet a
range of challenges and opportunities along the way.
But for all of us, it’s critical that we are prepared for our journeys in the
right vessel, keep our destinations in mind, stick with the plans, and have a
trusted navigator to chart our courses and keep us on target.
Adapted from “Sailing with the Tides,” Outside the Flags by Jim Parker, March 2018. Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Diversification does not eliminate
the risk of market loss. All expressions of opinion are subject to change. This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular
security, products, or services. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
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Market Summary
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Market segment (index representation) as follows: US Stock Market (Russell 3000 Index), International Developed Stocks (MSCI World ex USA Index [net div.]), Emerging Markets (MSCI Emerging Markets Index [net div.]), Global Real Estate (S&P Global REIT Index [net div.]), US Bond Market (Bloomberg Barclays US Aggregate Bond Index), and Global Bond ex US Market (FTSE WGBI ex USA 1−30 Years [hedged to USD]). S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2018, all rights reserved. Bloomberg Barclays data provided by Bloomberg. FTSE fixed income © 2018 FTSE Fixed Income LLC, all rights reserved.
US Stock
Market
International
Developed
Stocks
Emerging
Markets
Stocks
Global
Real
Estate
US Bond
Market
Global
Bond
Market
ex US
Q1 2018 STOCKS BONDS
-0.64% -2.04% 1.42% -5.79% -1.46% 0.94%
Since Jan. 2001
Avg. Quarterly Return 1.9% 1.5% 3.2% 2.5% 1.1% 1.1%
Best 16.8% 25.9% 34.7% 32.3% 4.6% 4.6%
QuarterQ2 2009 Q2 2009 Q2 2009 Q3 2009 Q3 2001 Q4 2008
Worst -22.8% -21.2% -27.6% -36.1% -3.0% -2.7%
QuarterQ4 2008 Q4 2008 Q4 2008 Q4 2008 Q4 2016 Q2 2015
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World Stock Market PerformanceMSCI All Country World Index with selected headlines from Q1 2018
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Graph Source: MSCI ACWI Index [net div.]. MSCI data © MSCI 2018, all rights reserved.It is not possible to invest directly in an index. Performance does not reflect the expenses associated with management of an actual portfolio. Past performance is not a guarantee of future results.
210
220
230
240
250
260
270
Jan Feb Mar
“Nasdaq Crests 7000
as Tech Giants Roar
Into 2018”
“Inflation Starts to
Make a Comeback”
“Dollar Drops to
Lowest Level
Since December
2014”
“Home Sales Post
Their Sharpest Drop
in Three Years”
“Congress
Passes
Mammoth
Spending Bill,
Averts
Shutdown”
“Oil Prices Hit Three-
Year Highs on Growth,
Geopolitics”
“US Imposes New Tariffs,
Ramping Up 'America
First' Trade Policy”
“Global Bonds
Swoon as Investors
Bet on Inflation”
“Eurozone Inflation
Continues to Lag,
Despite Robust
Economic Growth”
“US Service-Sector
Activity Hits
Decade-High”
“Dow Industrials
Plunge into
Correction”
“China's Economy Grows
Faster Than Expected on
Strong Demand for Exports”
“EU Agrees on Brexit
Transition Terms but
Ireland Issue Remains”
“US to Apply Tariffs
on Chinese Imports,
Restrict Tech Deals”
“Fed Raises Rates and
Signals Faster Pace in
Coming Years”
“US Stocks
Surge, but Dow
and S&P 500
Fall for the
Quarter”
These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.
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World Stock Market PerformanceMSCI All Country World Index with selected headlines from past 12 months
The Helmstar Group is a Registered Investment Advisory Firm
These headlines are not offered to explain market returns. Instead, they serve as a reminder that investors should view daily events from a long-term perspective and avoid making investment decisions based solely on the news.Graph Source: MSCI ACWI Index [net div.]. MSCI data © MSCI 2018, all rights reserved.It is not possible to invest directly in an index. Performance does not reflect the expenses associated with management of an actual portfolio. Past performance is not a guarantee of future results.
Short Term (Q2 2017–Q1 2018)
150
160
170
180
190
200
210
220
230
240
250
260
270
Mar-2017 Jun-2017 Sep-2017 Dec-2017 Mar-2018
Long Term (2000–Q1 2018)
0.00
50.00
100.00
150.00
200.00
250.00
300.00
2000 2005 2010 2015
Last 12
months
“Eurozone Confidence
Hits Postcrisis High”
“Global Stocks Post
Strongest First Half
in Years, Worrying
Investors”
“Unemployment Rate
Falls to 16-Year Low,
But Hiring Slows”
“US Companies
Post Profit Growth
Not Seen in Six
Years”
“Household Debt Hits
Record as Auto Loans
and Credit Cards Climb”
“Dollar Hits
Lowest Level in
More than 2½
Years”
“US Factory Activity
Hits 13-Year High”
“New-Home Sales
Growth Surges to 25-
Year High”
“Oil Hits Two-Year Highs
as US Stockpiles Drop”
“US Economy Reaches
Its Potential Output for
First Time in Decade”
“UK, EU Reach
Deal on Brexit
Divorce Terms”
“Trump Signs
Sweeping Tax
Overhaul Into
Law”
“Nasdaq Crests 7000
as Tech Giants Roar
Into 2018”
“Inflation Starts
to Make a
Comeback”
“Congress
Passes
Mammoth
Spending
Bill, Averts
Shutdown”
“US Imposes New Tariffs,
Ramping Up 'America
First' Trade Policy”
“US Service-Sector Activity
Hits Decade-High”
“Fed Raises Rates
and Signals Faster
Pace in Coming
Years”
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World Asset ClassesIndex Returns (%)
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2018, all rights reserved. Dow Jones data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Bloomberg Barclays data provided by Bloomberg. Treasury bills © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).
Looking at broad market indices, emerging markets outperformed developed markets, including the US, in the first quarter.
The value effect was positive in emerging markets but negative in developed markets, including the US. Small caps outperformed large caps in developed markets, including the US, but underperformed in emerging markets.
-0.08
-0.50
-0.64
-0.69
-0.76
-1.18
-1.26
-1.46
-2.04
-2.52
-2.64
-2.83
-7.43
1.62
1.42
0.34
0.17
MSCI Emerging Markets Value Index (net div.)
MSCI Emerging Markets Index (net div.)
One-Month US Treasury Bills
MSCI Emerging Markets Small Cap Index (net div.)
Russell 2000 Index
MSCI World ex USA Small Cap Index (net div.)
Russell 3000 Index
Russell 1000 Index
S&P 500 Index
MSCI All Country World ex USA Index (net div.)
S&P Global ex US REIT Index (net div.)
Bloomberg Barclays US Aggregate Bond Index
MSCI World ex USA Index (net div.)
MSCI World ex USA Value Index (net div.)
Russell 2000 Value Index
Russell 1000 Value Index
Dow Jones U.S. Select REIT Index
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US StocksIndex Returns
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Market segment (index representation) as follows: Marketwide (Russell 3000 Index), Large Cap (Russell 1000 Index), Large Cap Value (Russell 1000 Value Index), Large Cap Growth (Russell 1000 Growth Index), Small Cap (Russell 2000 Index), Small Cap Value (Russell 2000 Value Index), and Small Cap Growth (Russell 2000 Growth Index). World Market Cap represented by Russell 3000 Index, MSCI World ex USA IMI Index, and MSCI Emerging Markets IMI Index. Russell 3000 Index is used as the proxy for the US market. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. MSCI data © MSCI 2018, all rights reserved.
The US equity market posted a negative return for the
quarter.
Value underperformed growth across large and small cap
indices.
Small caps outperformed large caps.
52%US Market $27.0 trillion
World Market Capitalization—US
-0.08
-0.64
-0.69
-2.64
-2.83
2.30
1.42
Small Growth
Large Growth
Small Cap
Marketwide
Large Cap
Small Value
Large Value
Ranked Returns for the Quarter (%)
Period Returns (%) * Annualized
Asset Class 1 Year 3 Years** 5 Years** 10 Years**
Marketwide 13.81 10.22 13.03 9.62
Large Cap 13.98 10.39 13.17 9.61
Large Value 6.95 7.88 10.78 7.78
Large Growth 21.25 12.90 15.53 11.34
Small Cap 11.79 8.39 11.47 9.84
Small Value 5.13 7.87 9.96 8.61
Small Growth 18.63 8.77 12.90 10.95
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International Developed StocksIndex Returns
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Market segment (index representation) as follows: Large Cap (MSCI World ex USA Index), Small Cap (MSCI World ex USA Small Cap Index), Value (MSCI World ex USA Value Index), and Growth (MSCI World ex USA Growth). All index returns are net of withholding tax on dividends. World Market Cap represented by Russell 3000 Index, MSCI World ex USA IMI Index, and MSCI Emerging Markets IMI Index. MSCI World ex USA IMI Index is used as the proxy for the International Developed market. MSCI data © MSCI 2018, all rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
In US dollar terms, developed markets outside the US
underperformed the US and emerging markets during the
quarter.
Value underperformed growth in non-US developed
markets across large and small cap indices.
Small caps outperformed large caps in non-US
developed markets.
World Market Capitalization—International Developed
37%International Developed Market$18.9 trillion
-2.96
-3.74
-4.31
-4.89
-0.50
-1.56
-2.04
-2.52
Small Cap
Growth
Large Cap
Value
Ranked Returns (%) Local currency US currency
Period Returns (%) * Annualized
Asset Class 1 Year 3 Years** 5 Years** 10 Years**
Large Cap 13.92 5.30 6.04 2.59
Small Cap 21.16 11.30 9.71 5.81
Value 11.66 4.46 5.44 2.08
Growth 16.28 6.06 6.58 3.03
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Emerging Markets StocksIndex Returns
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Market segment (index representation) as follows: Large Cap (MSCI Emerging Markets Index), Small Cap (MSCI Emerging Markets Small Cap Index), Value (MSCI Emerging Markets Value Index), and Growth (MSCI Emerging Markets Growth Index). All index returns are net of withholding tax on dividends. World Market Cap represented by Russell 3000 Index, MSCI World ex USA IMI Index, and MSCI Emerging Markets IMI Index. MSCI Emerging Markets IMI Index used as the proxy for the emerging market portion of the market. MSCI data © MSCI 2018, all rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes.
In US dollar terms, emerging markets outperformed
developed markets, including the US, during the quarter.
The value effect was positive in large cap indices but
negative in small cap indices within emerging markets.
Small caps underperformed large caps in emerging
markets.
12%Emerging Markets$6.3 trillion
World Market Capitalization—Emerging Markets
0.94
0.72
0.50
-0.53
1.62
1.42
1.22
0.17
Value
Large Cap
Growth
Small Cap
Ranked Returns (%) Local currency US currency
Period Returns (%) * Annualized
Asset Class 1 Year 3 Years** 5 Years** 10 Years**
Large Cap 24.93 8.81 4.99 3.02
Small Cap 18.62 7.23 4.58 4.36
Value 18.14 6.65 2.57 2.07
Growth 31.73 10.89 7.30 3.87
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Select Country PerformanceIndex Returns
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Country performance based on respective indices in the MSCI World ex US IMI Index (for developed markets), MSCI USA IMI Index (for US), and MSCI Emerging Markets IMI Index. All returns in USD and net of withholding tax on dividends. MSCI data © MSCI 2018, all rights reserved. UAE and Qatar have been reclassified as emerging markets by MSCI, effective May 2014.
In US dollar terms, Finland and Italy recorded the highest country performance in developed markets, while Canada and Australia posted the
lowest returns for the quarter. In emerging markets, Egypt and Brazil posted the highest country returns, while the Philippines and Poland
had the lowest performance.
-0.04
-0.92
-1.04
-3.52
-3.71
-4.40
-5.53
-8.02
-8.36
-10.68
12.97
11.61
9.43
9.26
8.63
6.91
6.90
5.85
4.96
3.88
2.75
1.91
1.55
0.86
Egypt
Brazil
Peru
Russia
Pakistan
Malaysia
Thailand
Czech Republic
Taiwan
Colombia
Qatar
China
Mexico
Chile
South Korea
Hungary
UAE
South Africa
Turkey
Greece
Indonesia
India
Poland
Philippines
Ranked Emerging Markets Returns (%)
-0.69
-0.74
-1.14
-1.54
-2.44
-3.24
-3.25
-3.50
-3.65
-4.11
-5.87
-7.47
6.45
4.70
3.00
2.70
2.59
2.34
1.06
1.05
0.80
0.66
0.24
Finland
Italy
Singapore
Norway
Austria
Portugal
Japan
New Zealand
Netherlands
Belgium
France
Denmark
US
Spain
Hong Kong
Sweden
Ireland
Germany
UK
Israel
Switzerland
Australia
Canada
Ranked Developed Markets Returns (%)
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Select Currency Performance vs. US Dollar
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. MSCI data © MSCI 2018, all rights reserved.
Currencies returns were mixed for the quarter. In developed markets, the Japanese yen appreciated by over 5.5% but the Canadian dollar
depreciated approximately 3%. In emerging markets, the Mexican peso appreciated by over 7% but the Pakistani rupee, Philippine peso, and
Turkish new lira all depreciated more than 4%.
-0.20
-1.45
-2.14
-4.29
-4.33
-4.38
7.19
6.85
4.63
4.48
4.22
3.50
3.00
2.06
1.89
1.77
1.45
0.85
0.44
0.42
0.12
Mexican peso (MXP)
Colombian peso (COP)
Malaysian ringgit (MYR)
South African rand (ZAR)
Thailand baht (THB)
Chinese yuan (CNY)
Czech koruna (CZK)
Taiwanese NT dollar (TWD)
Chilean peso (CLP)
Hungary forint (HUF)
Poland new zloty (PLZ)
Egyptian pound (EGP)
South Korean won (KRW)
Peru new sol (PEI)
Russian ruble (RUB)
Brazilian real (BRC)
Indonesia rupiah (IDR)
Indian rupee (INR)
Turkish new lira (TRY)
Philippine peso (PHP)
Pakistani rupee (PKR)
Ranked Emerging Markets (%)
-0.39
-1.12
-1.93
-2.24
-2.82
5.92
4.18
3.70
2.42
2.30
1.91
1.76
1.43
Japanese yen (JPY)
Norwegian krone (NOK)
British pound (GBP)
Euro (EUR)
Danish krone (DKK)
Singapore dollar (SGD)
Swiss franc (CHF)
New Zealand dollar (NZD)
Hong Kong dollar (HKD)
Israel shekel (ILS)
Australian dollar (AUD)
Swedish krona (SEK)
Canadian dollar (CAD)
Ranked Developed Markets (%)
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Real Estate Investment Trusts (REITs)Index Returns
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Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Number of REIT stocks and total value based on the two indices. All index returns are net of withholding tax on dividends. Total value of REIT stocks represented by Dow Jones US Select REIT Index and the S&P Global ex US REIT Index. Dow Jones US Select REIT Index used as proxy for the US market, and S&P Global ex US REIT Index used as proxy for the World ex US market. Dow Jones data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. S&P data copyright 2018 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
Non-US real estate investment trusts outperformed
US REITs
56%US $618 billion 101 REITs
44%World ex US$477 billion 253 REITs (23 other countries)
Total Value of REIT Stocks
-1.26
-7.43
Global REITs (ex US)
US REITs
Ranked Returns (%)
Period Returns (%) * Annualized
Asset Class 1 Year 3 Years** 5 Years** 10 Years**
Dow Jones US Select REIT Index -3.68 0.74 5.97 6.02
S&P Global ex US REIT Index (net div.) 10.20 3.59 3.73 2.51
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CommoditiesIndex Returns
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Past performance is not a guarantee of future results. Index is not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Commodities returns represent the return of the Bloomberg Commodity Total Return Index. Individual Commodities are sub-index values of the Bloomberg Commodity Total Return Index. Data provided by Bloomberg.
The Bloomberg Commodity Index Total Return declined
0.40% during the first quarter.
The grains complex led performance, with soybean meal
returning 20.24% and corn gaining 8.30%. Energy also
advanced, with WTI crude oil returning 8.40% and Brent
oil advancing 4.99%.
Softs was the worst-performing complex, with sugar and
coffee declining by 18.19% and 7.96%, respectively.
Period Returns (%)
Asset Class 1 Year 3 Years** 5 Years** 10 Years**
Commodities 3.71 -3.21 -8.32 -7.71
* Annualized
-0.71
-1.21
-4.76
-5.59
-7.21
-7.96
-8.91
-10.76
-11.07
-12.37
-18.19
20.24
8.40
8.30
7.46
6.02
4.99
3.79
2.81
2.20
0.56
0.49
Soybean meal
WTI crude oil
Corn
Soybeans
Kansas wheat
Brent oil
Nickel
Wheat
Cotton
Gold
Unleaded gas
Heating oil
Zinc
Soybean oil
Silver
Natural gas
Coffee
Copper
Live cattle
Lean hogs
Aluminum
Sugar
Ranked Returns for Individual Commodities (%)
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Fixed IncomeIndex Returns
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One basis point equals 0.01%. Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. Yield curve data from Federal Reserve. State and local bonds are from the S&P National AMT-Free Municipal Bond Index. AAA-AA Corporates represent the Bank of America Merrill Lynch US Corporates, AA-AAA rated. A-BBB Corporates represent the Bank of America Merrill Lynch US Corporates, BBB-A rated. Bloomberg Barclays data provided by Bloomberg. US long-term bonds, bills, inflation, and fixed income factor data © Stocks, Bonds, Bills, and Inflation (SBBI) Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield). FTSE fixed income indices © 2018 FTSE Fixed Income LLC, all rights reserved. ICE BofAML index data © 2018 ICE Data Indices, LLC.
Interest rates increased in the US during
the first quarter. The yield on the 5-year
Treasury note rose 36 basis points (bps),
ending at 2.56%. The yield on the 10-
year Treasury note increased 34 bps to
2.74%. The 30-year Treasury bond yield
rose 23 bps to finish at 2.97%.
On the short end of the yield curve, the 1-
month Treasury bill yield increased 35
bps to 1.63%, while the 1-year Treasury
bill yield rose 33 bps to 2.09%. The 2-
year Treasury note finished at 2.27%
after a yield increase of 38 bps.
In terms of total return, short-term
corporate bonds dipped 0.38% and
intermediate corporates fell 1.50%. Short-
term municipal bonds advanced 0.10%,
while intermediate munis declined 1.29%.
Revenue bonds performed in-line with
general obligation bonds, declining 1.19%
and 1.20%, respectively.
2.74
3.23 3.32
3.88
10-Year USTreasury
Municipals AAA-AACorporates
A-BBBCorporates
Bond Yields across Issuers (%)
Period Returns (%)
Asset Class 1 Year 3 Years** 5 Years** 10 Years**
Bloomberg Barclays Municipal Bond Index 2.66 2.25 2.73 4.40
Bloomberg Barclays US Aggregate Bond Index 1.20 1.20 1.82 3.63
Bloomberg Barclays US Government Bond Index Long 3.53 0.45 3.28 5.75
Bloomberg Barclays US High Yield Corporate Bond Index 3.78 5.17 4.99 8.27
Bloomberg Barclays US TIPS Index 0.92 1.30 0.05 2.93
FTSE World Government Bond Index 1-5 Years 5.77 2.36 -0.37 0.57
FTSE World Government Bond Index 1-5 Years (hedged to USD) 1.01 1.06 1.21 1.93
ICE BofAML 1-Year US Treasury Note Index 0.66 0.54 0.42 0.71
ICE BofAML 3-Month US Treasury Bill Index 1.11 0.53 0.34 0.34
* Annualized
3/31/2017
12/29/2017
3/29/2018
0.00
1.00
2.00
3.00
4.00
US Treasury Yield Curve (%)
1
Yr
5
Yr
10
Yr
30
Yr
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Impact of DiversificationIndex Returns
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1. STDEV (standard deviation) is a measure of the variation or dispersion of a set of data points. Standard deviations are often used to quantify the historical return volatility of a security or portfolio. 2. Diversification does not eliminate the risk of market loss. Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect expenses associated with the management
of an actual portfolio. Asset allocations and the hypothetical index portfolio returns are for illustrative purposes only and do not represent actual performance. Global Stocks represented by MSCI All Country World Index (gross div.) and Treasury Bills represented by US One-Month Treasury Bills. Globally diversified allocations rebalanced monthly, no withdrawals. Data © MSCI 2018, all rights reserved. Treasury bills © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).
These portfolios illustrate the performance of different
global stock/bond mixes. Mixes with larger allocations to
stocks are considered riskier but have higher expected
returns over time.
Asset Class 1 Year 3 Years** 5 Years**10 Years**
10-Year
STDEV1
100% Stocks 15.44 8.71 9.79 6.15 16.72
75/25 11.74 6.70 7.44 4.94 12.54
50/50 8.11 4.65 5.07 3.55 8.35
25/75 4.54 2.57 2.68 1.99 4.16
100% Treasury Bills 1.03 0.45 0.28 0.28 0.14
Period Returns (%) * Annualized
-0.19
-0.50
-0.84
0.34
0.09
100% Treasury Bills
25/75
50/50
75/25
100% Stocks
Ranked Returns (%)
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
12/1988 12/1993 12/1998 12/2003 12/2008 12/2013
Growth of Wealth: The Relationship between Risk and Return
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By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
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• We suspect the bull market in U.S. equities is somewhere near the beginning of the end.
• This particular phase can last a few years if all goes well, but the ride will likely be bumpier than in recent years.
• We believe that economic fundamentals still justify further gains in U.S. and global equity prices.
Now this is not the end. It is not even the beginning of the end. But it is perhaps the end of the beginning. -U.K. Prime Minister Winston Churchill at the Lord Mayor’s Luncheon at Mansion House in London, November 10, 1942
That famous quote from the illustrious British Prime Minister was referencing the Allied victory at the second battle of Al Alamein, Egypt, during World War II. It proved to be the decisive engagement in the North African Campaign, a battle between the Axis Powers of Germany and Italy and the Allied Powers led by the U.K. and assisted by Commonwealth nations with U.S. air power, that allowed the Allies to dominate the Mediterranean Sea and prepare for the invasion of Italy. Churchill was right—it was only the end of the beginning. The war in Europe would continue for an additional two-and-a-half years.
We last referenced Churchill’s quotation in our thirdquarter 2015 Economic Outlook, suggesting that the bull market in global equities wasn’t ending or even at the beginning of the end. At the time, financial markets were undergoing a spate of increased volatility, but we were convinced that the correction would be short-lived and of limited magnitude. As Exhibit 1 illustrates, this turned out to be the correct call.
Although equities didn’t bottom out until late January/early February 2016, the subsequent rally was strong and prolonged. From the end of the third quarter in 2015 through the end of March 2018, the MSCI USA Index
(Total Return) leapt a cumulative 44%, while the MSCI ACWI ex-USA Index (Total Return) climbed 30% in localcurrency terms and about 37% in U.S. dollar terms.
And so, in the Churchillian scheme of things, where are we now? Our guess is that the bull market in U.S. equities is somewhere near the beginning of the end, while it may be closer to the end of the beginning in other countries. Let’s be clear: we are NOT saying that the bull market is ending in any part of the world, any time soon. Rather, we are noting that the fundamental, technical and psychological factors driving equity-market performance appear consistent with the latter stages of an up cycle. If all goes well, the duration of this particular phase can last a few years, but the ride will likely be bumpy. We still do not see many serious signs of overvaluation or economic imbalances that would
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Credit spreads continue to tighten as defaults reach low levels and credit quality improves despite the releveraging of corporate and consumer balance sheets.
In the final (stress) phase of the bull market, the advance in equity prices becomes more labored. Economic growth tends to slow and inflation accelerates as labor shortages develop and other input prices increase. Profit margins decline and earnings flatten out, although the price-toearnings ratio can remain elevated or even expand. Fixed-income yields tend to rise on inflation fears and additional monetary policy tightening by the U.S. Federal Reserve (Fed)
suggest imminent danger of a severe correction of 15% or more, much less a devastating bear market on par with the 2008-to-2009 experience.
The Market Cycle
Let’s examine the economic- and market-related factors that characterize a late-cycle bull market. Exhibit 2 provides a stylized cycle analysis of equities and fixed- income asset classes. During an expansion phase, the economy grows at a healthy pace, interest rates begin to rise and the yield curve tends to flatten (yields and prices move inversely). Strong profitability leads to increasing investor optimism and rising earnings multiples. Equities perform well. Fixed-income markets, meanwhile, come under pressure as the central bank begins to nudge policy rates higher.
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Although we saw the Chicago Board Options Exchange (CBOE) Volatility Index (known by its ticker symbol, VIX) pop dramatically in February to an intraday high of 50, that move appears to have been a technical reaction to the implosion of short-volatility strategies that seek to profit from what had been a lack of financial market volatility. It certainly did not lead to the kind of plunge in equity prices ordinarily associated with a 50 reading in the VIX.
The yield curve shifts upward and narrows, with the spread between short- and long-term rates approaching zero; the yield curve usually inverts (short-term rates rise above long-term yields) 6-to-12 months before a recession. During this stress phase, corporate credit spreads are tight but can begin to widen. Exhibit 3 takes a deeper dive into the behavior of various market and economic indicators during the different phase of the cycle.
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The central bank raised its policy rate for the first time in December 2015—more than six years after the peak in the unemployment rate. In previous cycles, the Fed initiated an up cycle in its policy rate within a year after unemployment began its descent. Owing to its concerns about the perceived fragility of the global expansion and the persistent downward pressure on inflation, however, the U.S. central bank refrained from boosting the federal funds rate again until December 2016. This reluctance to normalize rates came despite steady improvement in the U.S. unemployment rate, which we show in Exhibit 5.
Last year was a different story: The Fed finally did what it said it would do, raising the federal funds rate three times. The central bank continued on the interest-rate normalization path with its most recent increase this past March, taking the rate to a target range of 1.50% to
Nonetheless, the Volatility Index appears to be settling into a higher trading range versus the ultra-low readings of the previous 18 months. Exhibit 4 shows the VIX futures curve at year-end 2017 as well as during the peak period of volatility on February 5, 2018. It also shows its value at the end of March 2018 and its median value between 2007 and 2017. The recent extreme gyrations are one of the few signs of stress to which bearish equity analysts can point, although longer-dated futures project a return to lower volatility levels.
By our reckoning, the U.S. has been in the expansion phase since early 2016. The rest of the world generally shows signs of remaining in the latter stages of the recovery phase. This is especially true with regard to monetary policy. The Fed began to taper its bond purchases in January 2014, and ended the active phase of quantitative easing in October of that year, while continuing to reinvest interest and maturing principal.
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yields in the years ahead is the fact that nominal Treasury bond yields are about even with inflation. Prior to this expansion, bond yields remained consistently above the inflation rate starting in 1981.
There are cyclical pressures pushing yields up from their historic lows. First, the U.S. economy is approaching, if not already past, the non-inflationary rate of unemployment. We anticipate that inflation will continue its drift higher in the months ahead. Second, the Fed has been steadily pushing up short-term rates, as we just noted. Quantitative tightening, meanwhile, will continue adding to the supply of Treasury bonds available for purchase—at a time when Treasury issuance is accelerating due to a widening government budget deficit. Finally, the rest of the world is on a stronger growth track; extraordinary monetary measures in Europe and Japan will eventually be reversed, as they have been in the U.S. The evidence strongly suggests that the U.S. 10-year bond will move above 3% this year.
1.75%. The Federal Open Market Committee (FOMC) continues to project two additional hikes before the end of 2018, and (unsurprisingly, in our view) revised its 2019 median forecast from two to three rate increases. We believe the FOMC may want to see how an outright contraction of its balance sheet affects the markets before making any additional changes in the projected path.
Although equity markets experienced their first real correction in some 20 months during this past February and March, the pullback does not look to us as the start of a more serious decline. We see two fundamental drivers behind the correction in equities and the return to more volatile price action generally. Of the fundamental drivers, the first is an upward shift in investors’ interest-rate expectations as the global economy kicks into a higher gear. The second is concern among market participants that recent actions on the trade front by U.S. President Donald Trump’s administration will lead to a broader trade war that could upend global growth and push inflation higher sooner.
In bond markets, the attention is on yields. Exhibit 6 compares the 10-year U.S. Treasury bond yield to the year-over-year change in the consumer price index over the past four decades. On the positive side, the 10-year Treasury bond yield is still well below the levels that prevailed during the 2001-to-2007 expansion, reflecting the fact that inflation is lower as well. The chart also shows that there have been several periodic yield jumps during this generation-long bull market in bonds. Each time, those increases reversed themselves and yields moved to new lows.
Is the current jump in the Treasury bond rate just another head fake or is it part of a prolonged bottoming process? Some observers have already announced the end of the secular bull market in bonds. Only time will tell whether this is truly the case. Bolstering the argument for higher bond
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The Treasury yield curve remains upward sloping and, in our opinion, still can narrow further without causing too many problems. Interest-rate spreads for investmentgrade, high-yield and emerging-market debt also remain near cycle lows. High-yield bonds, in particular, should be considered the canary in the coal mine. Spreads tend to widen well before the stock market tops out. Exhibit 8 shows that the spread remains near its cyclical low. Even during the recent turbulence in the stock market, the option-adjusted spread (OAS) on high-yield bonds held surprisingly steady.
The long bull market in equities and other risk-oriented assets has been sustained by the extraordinarily expansive monetary policies of the world’s most important central banks. The subsequent decline in yields across the maturity spectrum reached levels never seen in the history of recorded interest rates as tracked by A History of Interest Rates 1. In our view, this 37-year tailwind is turning into a headwind.
Increased financial-market volatility and the rising trend in bond yields have been duly reflected in the St. Louis Fed Financial Stress Index. Still, as shown in Exhibit 7, the index remains below its average level going back to 1994, and is nowhere near the sky-high levels reached during the global financial crisis.
1 A History of Interest Rates, Wiley Finance Series, 4th Edition
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Investors should take some solace in the thought that interest rates usually must rise substantially before the stock market turns down in a major way. Obviously, every cycle is different, as the market response is influenced by a variety of factors, including valuation, the stage of the business cycle and the level from which bond yields begin to increase.
SEI’s U.S. large-cap focused portfolios took advantage of the February stock-market dip to equitize excess cash. Cyclical stocks were slightly favored. Exposure to value was increased during the first quarter, since that particular factor looks stretched to the downside relative to momentum and stability. In terms of sectors, financial stocks were overweighted; the sector was appealing to value- and growth-oriented portfolios alike. Low-volatility stocks started to become more attractive
Although the ride has turned bumpier, we believe that economic fundamentals justify further gains in equity prices. The global expansion is still alive. Earnings continue to climb. American companies’ cash flows and earnings, meanwhile, are benefiting mightily from U.S. tax reform. There really are few signs that the U.S. will see a recession anytime in the next 12 to 18 months.
As we have pointed out in the past, the U.S. equity market historically has withstood the depressive impact of rising interest rates until the 10-year bond reaches a level of 4% to 5%. Owing to the structural decline in bond yields and the elevated equity valuations that have resulted, we now think it prudent to assume that the stock market will begin to struggle if the 10-year Treasury bond rate approaches 4%, the lower end of the traditional danger zone. A recent analysis by RBC Capital Markets2 tracked S&P 500 Index performance during periods of rising bond yields. The study shows 18 occasions since 1962 during which the 10year Treasury bond yield climbed by at least 125 basis points (1.25 percentage points) from the cyclical low point to the cyclical high. The current cycle represents the nineteenth such climb, with the bond yield up 140 basis points since the low of 1.36 set in July 2016.
Although stock-market returns are highly variable, there is a tendency for poor performance when the bond yield increases by more than 275 basis points off the lows. Exhibit 9 shows that the S&P 500 Index has logged an average price-only increase of 19.4% and a median rise of 14.4% when the trough-to-peak gain in the 10-year Treasury bond has been less than 275 basis points. When the rise exceeds 275, the average and median S&P 500 Index price change totals -3.0% and -1.4%, respectively.
2 Lori Calvasina and Sara Mahaffey, The RBC Macroscope, RBC Capital Markets, LLC., Feb. 12, 2018, p. 48
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Not so Tariff-ic
While we maintain a positive view of equities and other risk assets, we must admit that our optimism is being tested as the Trump administration uses protectionism as a bargaining tool against friend and foe alike. In our view, the imposition of tariffs on any product is harmful in and of itself—it hurts consumers and industrial users of the product much more than it helps the producers. The only good news regarding tariffs: the specific measures on aluminum and steel announced thus far should have a limited impact on economic growth and inflation. Besides, the U.S. administration has been handing out temporary exemptions to its allies, with the notable exception of Japan. South Korea, thus far, is the only country to gain a permanent exemption from the steel tariffs, since it agreed to steel quotas and other measures beneficial to U.S. auto and truck makers. America’s North American Free Trade Agreement (NAFTA) partners, Canada and Mexico, are high on the list of countries that export steel and aluminum to the U.S. They were the first two countries to be given temporary reprieves by the Trump administration as encouragement to come to terms on a revised agreement more favorable to U.S. interests.
We are in watchful waiting mode when it comes to trade. The unveiling of tariffs on Chinese goods is concerning, which we will explore more fully below. Even if the World Trade Organization rules against the tariffs imposed by the U.S., we seriously wonder whether President Trump would care. A trade war of consequence could add to the inflation pressures that already are emerging as a result of the pick-up in economic activity and the tightening employment situation.
after several years of overvaluation, leading to a modest overweight in healthcare and consumer staples. The biggest underweight in SEI’s active large-cap portfolios was in technology. Interest-rate sensitive sectors (utilities, telecommunications and real estate) were also underweight, given concerns about rising rates. Energy stocks also remained underweight; valuations were attractive, but there was no momentum.
Our small- and mid-cap portfolios were more defensively positioned. There have been concerns about the relatively high-debt positions of smaller companies, with debt ratios appreciably above the levels prior to the global financial crisis. Valuations were also concerning. Growth and quality appeared expensive. Value stocks looked to be relatively attractive given their material underperformance over the past few years. On the positive side, tax cuts have been a big positive for SEI’s small-cap portfolios, since the percentage of firms we held that have no earnings was much smaller than the percentage in the benchmark. The largest sector overweights were in technology, consumer discretionary and industrials. Utilities, real estate, materials and energy tended to be below their benchmark weights.
In fixed income, SEI’s core portfolios continued adding duration as bond yields climbed, bringing them neutral or slightly long the benchmark. They still favored credit, with overweight positions in asset-backed securities, commercial mortgage-backed securities and non-agency mortgage-backed securities. In U.S. fixed income, there was an active short-duration bias and portfolios were holding more cash to take advantage of opportunities in the mergers-and-acquisitions credit space. SEI’s shortterm portfolios had significant holdings in floating-rate debt in anticipation of additional Fed rate increases. In U.S. high yield, our portfolios were short the benchmark’s duration; bank-loan exposure increased slightly.
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• Fourth, valuation considerations support our bullish rationale. As Exhibit 10 illustrates, the price-toforward-earnings ratio for the eurozone normally lags that of the U.S. But this discounted value has widened in recent years despite the better economic news coming out of the region.
• Fifth, but not least, there was a political dimension to our pro-eurozone equity rationale. We figured the political turmoil depressing eurozone valuations would subside or, at the very least, not look out of line against the political uncertainty and polarization emanating from the U.S. or the U.K. Obviously, the rise of radical parties and the fading of established centrist ones can pose a problem for both the eurozone and the greater European Union (EU). The recent election in Italy highlights the growing strength of anti-immigrant, anti-EU and antimonetary union feeling in that country.
We think it’s premature to expect the worst, however. Until there is more clarity on the extent of the U.S. protectionist measures being put into place, we think it’s best to focus on the strong fundamental backdrop. Profits growth remains vibrant, inflation is still well-contained, and Fed decision makers have made clear they’d prefer to normalize monetary policy in a steady, predictable fashion. For now, we favor maintaining a risk-on investment orientation.
The European Theater
We’ve been disappointed by the poor relative performance of eurozone equities since the middle of last year. It has been our conviction that eurozone shares, as measured by the MSCI EMU (European Economic and Monetary Union) Index (Total Return), would outperform the MSCI USA Index (Total Return).
Our rationale is fivefold: • First, the eurozone economy has been gaining traction since early
2016; region-wide gross domestic product outpaced U.S. growth in 2017. Investors began to diversify their exposure away from the U.S., as we expected, with fears of deflation and endless austerity in Europe having faded.
• Second, the potential for future growth was judged to be much greater in the eurozone than in the U.S. since Europe appeared to be in the early stages of its recovery, with labor and capital utilization quite low and monetary policy still extremely accommodative.
• Third, we looked for a decent rise in corporate revenues and an even sharper jump in earnings, given the fact that European companies are saddled with high fixed costs, implying a high degree of operational leverage.
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for the U.S. According to figures from the Organization for Economic Co-operation and Development, the euro remains below its purchasingpower parity value against the U.S. dollar. In addition, Exhibit 12 shows that, on a broad trade-weighted basis, the euro’s inflation-adjusted exchange rate appears to be only in the middle of its trading range since 2010, and well below its average level recorded between 2003 and 2009. The nominal exchange rate, by contrast, is hovering near its previous cyclical high, and reflects the fact that inflation in the eurozone has been consistently below the domestic inflation rates of most of its trading partners.
But we’ve seen progress too. Greece has been off the front pages for the past two years. Spain appears to be settling into an uneasy status quo after the latest election in Catalonia. Germany has finally gotten its grand coalition (although Chancellor Angela Merkel’s political power is probably past its peak and the far-right Alternative für Deutschland party continues to gain popularity). France, the eurozone’s second biggest economy behind Germany, is making its strongest effort yet to push through labor and social reforms aimed at improving economic flexibility and productivity.
So why has Europe continued to lag? Exhibit 11 shows that the relative performance of the MSCI EMU Index (Total Return) recently touched a new all-time low against the MSCI USA Index, both in local-currency terms. Thanks to a strengthening euro against the U.S. dollar, eurozone equities outperformed on a common-currency basis last year; however, it also can be seen that they have been struggling this year even when the euro’s appreciation is taken in to account. Exhibit 11 also shows the euro’s ups and downs against the U.S. dollar. For the most part, the euro and the MSCI EMU Index strengthened together, relative to their U.S. counterparts, between 2003 and 2007. During the global financial crises and its immediate aftermath, the euro fell sharply and the MSCI EMU Index (Total Return) declined versus the MSCI USA Index (Total Return). Thereafter, the correlation loosened. Since 2015, the euro has stabilized and recovered, while the relative strength of the eurozone’s stock market has continued to weaken. We’ve been looking for a reemergence of the prior relationship, so far in vain.
The euro’s appreciation to date has not prevented the region’s economic rebound, although it may be tempering earnings expectations: one-year forward consensus earnings growth is estimated at 8.0% versus 18.0% for 2017 and a tax-reform-aided forward earnings-growth estimate of 19.9%
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Exhibit 13 shows how growth has walloped value on a relative basis in the U.S., with the run beginning more than 10 years ago. Since last October, the performance divergence has widened dramatically and is reminiscent of what took place during the tech bubble of 1998 to 1999. Outside the U.S., growth stocks have exhibited little tendency to outperform value since 2003.
On a fundamental basis, we think investors remain rather skeptical about the staying power of the European expansion. This is especially so as the European Central Bank (ECB) tapers its bond purchases. Whether quantitative easing ends in September or continues for a few additional months is immaterial. The ECB is clearly moving away from supporting the eurozone’s economic recovery and credit markets via its asset purchases. And by mid-year 2019, if not sooner, we should see the first steps toward normalizing policy rates—although negative yields are an absurdly low starting point.
We think the most important reason for the muted performance, however, is the composition of the European equity market. The MSCI EMU Index is a value-oriented index whose market capitalization is dominated by financials, industrials and consumer discretionary companies. The MSCI USA Index, by contrast, has an increasingly pronounced orientation toward growth. The technology sector alone accounts for 25.5% of the MSCI USA Index versus just 8.5% in the MSCI EMU Index. Financial stocks, by contrast, make up 21% of the MSCI EMU Index, but less than 15% of the MSCI USA Index. Since technology has been such a strong relative performer in recent years, the U.S. market has been hard to beat. In our opinion, valuations in U.S. technology and in growth areas generally have become somewhat stretched; although we must admit that the technology sector’s profits growth has been stellar.
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foreign exchange market. Even though economic growth remains positive, it has failed to keep up with the elevated expectations of market participants. Exhibit 14 also shows that the trajectory of the eurozone reading (often referred to as “the second derivative” of growth) correlates decently well with the three-month percentage change in the MSCI EMU Index (Total Return).
Investors in eurozone equities seem to be reacting to the prospect of reduced ECB support in the same fashion that investors in U.S. risk assets did when the Fed tried to wean the economy off quantitative easing in the years following the global financial crisis. The U.S. stock market registered sharp, albeit brief, corrections after the first and second rounds of quantitative easing (known, in turn, as QE1 and QE2) ended in 2010 and 2011, respectively. Stocks wobbled again in mid-2013 when then-Fed Chair Ben Bernanke announced the central bank’s intention to taper its bond purchases toward the end of that year. Of course, one cannot blame the U.S. equity market’s negative reaction at the time entirely on stop-and-go quantitative easing. Other factors came into play. In 2010, the full dimension of the periphery debt crisis in Europe was just starting to dawn on investors. More generally, the global recovery was still in its early stages; it was feared that there would be an economic relapse as the U.S. central bank withdrew its support. In 2011, the ending of QE2 coincided with a shutdown of the federal government and the debt-ceiling debacle that raised the unthinkable possibility of a technical default by the U.S. Treasury.
Beyond these idiosyncratic factors, there was a definite tendency for stocks to appreciate when the Fed provided liquidity to the financial markets through its bond purchases. When that liquidity source was taken away—or even just the possibility of removal mentioned—stocks hit an air pocket of some consequence.
Europe now looks to be where the U.S. was in the 2010to-2013 period. The eurozone economy is certainly on sounder economic footing than it was a few years ago, although recent economic data have disappointed investors and traders. Exhibit 14 highlights the Citigroup Economic Surprise Index for the eurozone. The index basically measures macro data outcomes versus Bloomberg’s survey of economists’ median expectations, and weights those outcomes on the basis of historical reactions in the
Consumer-price inflation in the eurozone also remains below target, causing many to wonder why the ECB is withdrawing its monetary support at this time. Core inflation is running at a rate of only 1% on a year-over-year basis, well below the ECB’s stated target of just below 2%. The Trump administration’s threat to engage in a trade war, which would hit Germany the hardest, surely is not helping investor sentiment either. At this point, though, we continue to assume that
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likely continue to so until there is far more clarity on the country’s future relationship with its biggest trading partner. A tentative agreement between Prime Minister May’s government and the EU on a transition deal is helpful, but does not make the future trading relationship itself any clearer.
that the fallout from the Trump administration’s aggressive trade stance will be limited, and that the improving global economic picture will enable the ECB to successfully taper its bond purchases without pushing the region back into recession.
U.K.’s Darkest Hour?
While the outlook for the eurozone is quite mixed, it seems bright and sunny compared to that of the U.K—where equities, as measured by the MSCI U.K. Index (Total Return) in local-currency terms, are down 7.3% in the year to date, versus -2.7% for the MSCI EMU Index (Total Return) and a 0.6% dip for the MSCI USA Index (Total Return). As we have mentioned in previous reports, Brexit has become the overwhelming obsession of investors and policymakers. Exhibit 15 suggests that consumers in the U.K. are particularly perturbed by the divorce. In recent months, a consumer confidence survey by German market research institute GfK has been meandering at its lowest level since 2013, a time when this measure was in the midst of a sharp recovery.
Consumer confidence in the eurozone, by contrast, has marched steadily higher since last summer, climbing to its highest level in nearly 18 years. Businesses in the U.K. do not appear quite as glum; their opinion about the future recovered nicely from the shock of the Brexit referendum, although confidence took a hit in March. Notably, businesses in the eurozone are still more optimistic than their U.K. counterparts.
We can understand why U.K. consumers are down in the dumps. Real wages have been eroding as year-over-year consumer-price inflation hovers around 2.7%. Businesses seem to be doing well, owing to the Brexit-related decline in the value of the pound and buoyant demand arising from the global economic recovery. But the uncertainties associated with Brexit are depressing investment in the U.K., and will
The latest wrinkle in the Brexit saga is the “conversion” of the LabourParty’s leader, Jeremy Corbyn, to side of the “Remainers.” He now backs a customs union that would keep the U.K. closely tied to the EU. This is a shrewd political move since it capitalizes on the rifts within the Conservative Party as well as on Prime Minister May’s currently low popularity. The odds of an early election (one doesn’t need to take place until 2022) and a Labour victory, with Corbyn elected as prime minister, are growing. Although a prime minister can be replaced without a general election, the Conservatives do not have a majority in
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in core markets. The European yield curve remained steep, so curve-flattener strategies were in place. Credit-sensitive assets were preferred versus rates ensitive sectors. An overweight to Treasury inflation protected securities and linkers was also a favored strategy.
Trade Wars Ahead in Asia?
Ever since Donald Trump’s presidential victory in November 2016, we have worried about U.S. trade policy taking a major protectionist turn. For the most part, though, the president’s bark during his first year in office was worse than his bite. He did, however, walk away from the Trans-Pacific Partnership and the Paris Agreement on climate change. He challenged Canada and Mexico on NAFTA, but did not pull out of the pact. He threatened to declare China a currency manipulator, but moved off that position as he sought President Xi Jinping’s cooperation in an effort to isolate and punish North Korea for its nuclear activities. He also toned down his rhetoric against South Korea and Germany. When General John Kelly was removed from his role as House chief of staff and Steve Bannon let go from his position as advisor, it seemed that the president might be convinced to moderate his long held views on trade.
That no longer appears to be the case. In January, the Trump administration imposed tariffs on washing machines and solar panels—actions largely directed at South Korea and China, but also hitting other Asian producers, such as Malaysia. Tariffs on aluminum and steel raised the ante a bit more. These measures probably can be likened to a “Phoney War” (where nothing much happens) that precedes a much larger undertaking—the imposition of trade restraints on China. The Trump administration announced on March 22 that it would impose 25% tariffs on up to $50 billion worth of goods (roughly 10% of the total value of Chinese imports into the U.S).
Parliament; they depend on the Democratic Unionist Party, based in Northern Ireland, to remain in power. The Conservatives hold power by the slimmest of threads nowadays; it conceivably could take only a handful of rebels to cause the government to fall.
Of course, as we mentioned in the past, Prime Minister May has managed to hang on precisely because the prospect of a government headed by Corbyn is beyond the pale for most Conservatives and political moderates. If Corbyn manages to gain the keys to 10 Downing Street, we would expect a radical policy shift to the left, both economically and socially. The “Corbynomics” program could include nationalization of the railroads and energy industries, a jump in corporate and personal marginal tax rates, and an end to fiscal austerity, among other dramatic changes. In addition, the country’s foreign policy could be upended, given Corbyn’s affection for Russia and antipathy toward the U.S. and the North Atlantic Treaty Organization. In our view, a Corbyn government would have nothing to offer investors but blood, toil, tears and sweat.
With regard to positioning, SEI portfolios with an MSCI World ex USA Index mandate remained positively positioned toward Europe, although expectations for absolute performance in the months ahead remain somewhat muted. The earnings picture still appears positive too, with the possibility for additional upgrades as the region’s economic recovery deepens. We believe the environment supports more domestically oriented companies, which implies a heavier mid-cap tilt versus larger-cap. There was a distinct tilt toward value, especially in the financial and industrial sectors. Interestrate-sensitive sectors remained underweighted. Momentum also was favored as a factor, while stability was underweighted. Given the dispersion in performance, some portfolios were shifting funds from the Continent to the U.K. equity market.
Bond portfolios tended to be short duration relative to the benchmark
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A New Phase for Equities
By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
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gained by the beneficiaries of protection. That being said, there is no denying that those in the U.S. on the losing side of the global trade equation have lost big over the past 30-plus years. The country as whole has benefited, and emerging economies like China certainly have profited, with hundreds of millions of people lifted out of poverty and a subsistence existence. This is scant solace for an American textile, auto or steelworker who lost a high-paying job and was unable to make the transition to another occupation with comparable income and benefits.
Trump was elected because he successfully tapped into the angst and discontent of those areas devastated by the loss of industries and jobs to China, Mexico and other lowcost, emerging economies. While we do not think his protectionist measures will result in some sort of American renaissance in manufacturing employment, his political base still will likely applaud. In fact, Trump’s approval rating has been rising steadily since the middle of December, from 37.3% to a current reading of almost 42% as of the end of March, according to the RealClearPolitics3 website, with his approval rating approaching its highest level since the early months of his presidency.
As is often the case with President Trump’s major policy initiatives, it is hard to determine how far he will press his maximalist position on trade against China. What appears to be clear is that the president holds a mercantilist, zerosum view of international trade: surpluses are good, while deficits are bad. There already has been a crackdown on China’s ability to take over certain U.S.-based companies (although it should be noted that the Committee on Foreign Investment in the United States is getting more aggressive on all transactions potentially involving sensitive technology transfers or national-security concerns).
Exhibit 16 compares the trade deficit the U.S. runs versus some of its major trading partners. This is viewed from the perspective of the U.S., which includes Chinese re-exports through Hong Kong. On this basis, China has been the single biggest contributor to the U.S. merchandise trade deficit, by far and away, with the gap recently hitting a new record. The U.S. trade deficit with the euro area has also continued to widen, but is still less than two-fifths of the deficit with China as of February. Excluding Germany, the euro area’s trade surplus versus the U.S. was greater than America’s trade gap against Mexico at the end of 2017.
Pick up an introductory economics textbook and you will find that the U.S. president’s view on trade is way outside the mainstream, discredited in both theory and practice. Impediments to trade (tariffs, quotas and non-tariff barriers) raise prices and reduce demand, leading to a dead-weight loss for society. More jobs are lost by consuming industries than are
3 https://www.realclearpolitics.com/epolls/other/ president_trump_job_approval-6179.html
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A New Phase for Equities
By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
The Helmstar Group is a Registered Investment Advisory Firm
In addition to the disruption of global supply chains emanating from a trade war with China, imports into China could be further constrained if domestic demand slows on tighter fiscal and monetary policies. Now that President Xi Jinping has consolidated his power and can rule China for as long as he pleases, there is less need to ensure that the country grows rapidly at the expense of exacerbating imbalances such as real-estate speculation, excess debt creation and the expansion of the shadow banking system. That said, February data suggest the Chinese economy kept up its momentum into the Lunar New Year. On the other hand, consumer prices have popped higher and interest rates are appreciably above year-ago levels at the end of March. We also would note that equity prices, as measured by the MSCI China Index (Total Return), have handily outpaced the MSCI ACWI Index in local-currency terms for the past two years.
When viewed together, the BRICS (Brazil, Russia, India and South Africa) in Exhibit 18, it’s clear that all are correlated to some extent. India tends to be the least volatile, while the other three commodity-rich countries dance to China’s tune more closely. Since the bottom in oil and metals commodity prices during the January-toFebruary 2016 period, Brazil’s equity market in total-return terms has climbed by more than 180% in U.S. dollar terms through the end of March. Russian stocks have appreciated almost 120%, while China and South Africa have seen a near-doubling in their MSCI benchmarks. India has lagged, with a gain of less than 50% as of the end of March, with investors responding to internal developments such as the demonetization shock in November 2016 and the tax reforms instituted in the middle of last year. Additionally, India is a more closed economy than the others and is therefore less affected by the cyclical ups and downs of world trade.
In addition, we believe the Trump administration has a legitimate criticism in the way China engages in unfair trading practices in areas like intellectual property and the forced transfer of technology from foreign companies that do business in China.
China will not be the only country hurt by U.S. protectionist actions. Its supplier countries will likely feel the blowback as well. As illustrated in Exhibit 17, South Korea, Japan and Taiwan account for one-quarter of China’s total imports, as of February 28, 2018. By comparison, the U.S. makes up less than 8% of China’s merchandise imports, while all of Europe accounts for 18.6%. Australia and Brazil combined account for another 8%.
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A New Phase for Equities
By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
The Helmstar Group is a Registered Investment Advisory Firm
Asia remained underweight as a region, however, mostly to avoid Chinese and Taiwanese banks. Latin America was overweight, with retailers in the region favored as they have benefitted from improving macroeconomic conditions. Cyclical companies such as steel and commodity-related investments remained attractive—as did technology, which stands to benefit from idiosyncratic opportunities and structural growth trends such as rising internet usage. Industrial stocks were favored on the back of strong global growth.
Our emerging-market debt portfolios also remained positioned for a positive outlook. Fundamentals were still solid, thanks to the synchronized global expansion and country-specific reforms that have led to broad improvement in many countries’ current-account balances and stronger foreign-currency reserve positions. Although our portfolios are short their duration benchmark in anticipation of higher interest rates, their holdings are biased toward local- over hard-currency (external) debt. Argentina had a meaningful overweight in our portfolios as economic reforms continued to be introduced. Our portfolios also held Czech local-currency debt, drawn by attractive yields. Meanwhile, South African political risk diminished as new leadership provided a market-friendly backdrop. Venezuela debt was also overweight since it trades 20 to 30 cents on the U.S. dollar, but with anticipated recovery potential around 40 cents. Underweights included Philippine and Romanian debt, which offer relatively low yields.
It is Always Wise to Look Ahead, but Difficult to Look Further than You Can See
We have focused a lot on the challenges facing global equities. While improvement in the global economy is certainly a good thing, it also means that central banks must begin to move away from the easy
In the event of a serious trade war and China slowdown, we would likely see the reversal of several trends. Resource-oriented emerging markets would lose ground as commodity prices sag. The 2014-to-2015 period was a tough one for the big emerging markets. Russia and Brazil were particularly weak—afflicted not just by China-related volatility and commodity-price weakness, but also by home-grown problems. On the other hand, India’s stock market held up well, underscoring its attraction as a lowerbeta, safe-haven play. The next few months could be pivotal for global markets, Asia especially.
SEI’s emerging-market portfolios were positioned to look past the current trade tensions and maintained a risk-on stance. During the sell-off in February, weights to technology names increased (mostly in Asia).
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A New Phase for Equities
By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
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impossible under split governance, with power more evenly distributed across the two major parties. We would also expect a Democratic House to ramp up the pace of investigations into the president, his staff and Cabinet.
The past nine years have been full of challenges and uncertainties. The years ahead don’t seem to promise anything different in that regard. Yet, the bull market has managed through it all. Let’s give it the benefit of the doubt for a while longer. As Winston Churchill once said, “If you’re going through hell, keep going.”
policy settings that made sense when growth was weak and the threat of deflation was a legitimate concern. As interest rates rise, equity valuations eventually will come under pressure. The absolute level of interest rates is still very low, however. As mentioned above, we think the bull market in U.S. equities certainly can be sustained until bond yields reach 4% or more.
The greater danger in the near-term is a potential policy mistake on trade. This has been on our radar screen since Trump was elected president. However, we would caution against getting overly pessimistic at this juncture. We prefer to see what trade sanctions are actually levied against China and how China responds, instead of assuming the worst from the get-go.
Another area of political concern is the electoral cycle. Italy still has the potential to depress European equity markets if the populist 5 Star Movement and regionalist Lega (formerly Lega Nord, or the Northern League) parties manage to cobble together a coalition government. At best, this would cause the usual kind of Italian political dysfunction; at worst, it could lead to additional worries about the solvency of the country and its commitment to the euro and the European project. The Brexit saga is also sure to continue in the months ahead, with pessimism over the outcome ebbing and flowing ahead of each discussion.
In the U.S., congressional elections will take place in November. Recent special elections, survey polling and a high-profile redistricting in Pennsylvania put Republican control of the House of Representatives in jeopardy. Midterm elections often see the party in power lose seats—but this year’s cycle could be a wave election for the Democrats, just as 2010 and 2014 were for Republicans when President Barack Obama occupied the White House. Legislating in the U.S. has been tough enough under a “unified” government of Republican control; it will become next to
The Helmstar Group is a Registered Investment Advisory Firm
A New Phase for Equities
By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
The Helmstar Group is a Registered Investment Advisory Firm
Spread is the additional yield, usually expressed in basis points (one basis point is 0.01%), that an index or security offers relative to a comparable duration index or security (the latter is often a risk-free credit, such as sovereign government debt). A spread sector generally includes non-government sectors in which investors demand additional yield above government bonds for assumed increased risk.
Index Definitions
CBOE Volatility Index (VIX): The VIX, or Chicago Board Options Exchange Volatility Index, uses option prices on the S&P 500 Index to estimate the implied volatility of the S&P 500 Index over the next 30 days. Options are derivative contracts that give a buyer the right (and impose upon the seller an obligation, if called upon by the buyer) to buy or sell an underlying security at a specified price, usually for a specified period of time. A higher number indicates greater volatility; an increase in the VIX is often associated with higher risk aversion among investors. Common usage: The Chicago Board Options Exchange Volatility Index (VIX), a barometer of market volatility.
Citigroup Economic Surprise Index (CESI): The Citigroup Economic Surprise Indexes (CESI) are objective and quantitative measures of economic news. They are defined as weighted historical standard deviations of data surprises (actual releases versus Bloomberg Barclays survey median). A positive reading of the CESI suggests that economic releases have, on balance, been beating consensus. The indexes are calculated daily in a rolling three-month window. The weights of economic indicators are derived from relative high-frequency spot FX impacts of 1 standard deviation data surprises. The indexes also employ a time decay function to replicate the limited memory of markets.
Glossary
Carry trade refers to a trade in which an investor takes advantage of the interest-rate difference between countries, borrowing from the country with lower rates and investing in the country with higher rates.
Cyclical sectors, industries or stocks are those whose performance is closely tied to the economic environment and business cycle. Cyclical sectors tend to benefit when the economy is expanding.
Duration is a measure of a security’s price sensitivity to changes in interest rates. Specifically, duration measures the potential change in value of a bond that would result from a 1% change in interest rates. The shorter the duration of a bond, the less its price will potentially change as interest rates go up or down; conversely, the longer the duration of a bond, the more its price will potentially change.
Option-Adjusted Spreads estimate the difference in yield between a security or collection of securities and comparable Treasurys after removing the effects of any special features, such as provisions that allow an issuer to call a security before maturity.
P/E ratio: The price-to-earnings ratio (P/E ratio) of a stock is equal to its market capitalization divided by its after-tax earnings. The higher the P/E ratio, the more the market is willing to pay for each dollar of annual earnings.
Purchasing power parity is the economic theory that exchange rates between currencies are in equilibrium when their purchasing power is equal in each country.
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A New Phase for Equities
By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
The Helmstar Group is a Registered Investment Advisory Firm
MSCI USA Index: The MSCI USA Index is designed to measure the performance of the large- and mid-cap segments of the U.S. market. With 632 constituents, the Index covers approximately 85% of the free float-adjusted market capitalization in the U.S.
MSCI World Index: The MSCI World Index is a free float-adjusted market-capitalization-weighted index that is designed to measure the equity-market performance of developed markets. The MSCI World Index consists of 24 developedmarket country indexes. S&P 500 Index: The S&P 500 Index is an unmanaged, market-weighted index that consists of 500 of the largest publicly traded U.S. companies and is considered representative of the broad U.S. stock market.
St. Louis Fed Financial Stress Index: The St. Louis Fed Financial Stress Index measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest-rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress. Accordingly, as the level of financial stress in the economy changes, the data series are likely to move together.
Consumer Price Index (CPI): The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them.
MSCI ACWI ex USA Index: The MSCI ACWI ex USA Index includes both developed- and emerging-market countries, excluding the U.S.
MSCI China Index: The MSCI China Index captures large- and mid-cap representation across China H and B shares, Red chips, P chips, and foreign listings (such as ADRs). With 151 constituents, the Index covers about 85% of this China equity universe.
MSCI EMU Index: The MSCI EMU Index (European Economic and Monetary Union) captures large- and mid-cap representation across the 10 developed-market countries in the European monetary union (EMU). With 247 constituents, the Index covers approximately 85% of the free float-adjusted market capitalization of the EMU.
MSCI Total Return Indexes: The MSCI Total Return Indexes measure the price performance of markets with the income from constituent dividend payments. The MSCI Daily Total Return (DTR) methodology reinvests an index constituent’s dividends at the close of trading on the day the security is quoted ex-dividend (the ex-date).
MSCI United Kingdom Index: The MSCI United Kingdom Index is designed to measure the performance of the largeand mid-cap segments of the U.K. market. With 102 constituents, the Index covers approximately 85% of the free floatadjusted market capitalization in the U.K.
The Helmstar Group is a Registered Investment Advisory Firm
A New Phase for Equities
By: James R. Solloway, CFA, Chief Market Strategist and Senior Portfolio Manager
The Helmstar Group is a Registered Investment Advisory Firm
This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the Funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including futures contracts. There is no assurance as of the date of this material that the securities mentioned remain in or out of SEI Funds.
There are risks involved with investing, including loss of principal. Current and future portfolio holdings are subject to risks as well. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume.
Narrowly focused investments and smaller companies typically exhibit higher volatility. Bonds and bond funds will decrease in value as interest rates rise. High-yield bonds involve greater risks of default or downgrade and are more volatile than investment-grade securities, due to the speculative nature of their investments.
Past performance does not guarantee future results Index returns are for illustrative purposes only and do not represent actual portfolio performance. Index returns do not reflect any management fees, transaction costs or expenses. One cannot invest directly in an index.
Certain economic and market information contained herein has been obtained from published sources prepared by other parties, which in certain cases have not been updated through the date hereof. While such sources are believed to be reliable, neither SEI nor its affiliates assumes any responsibility for the accuracy or completeness of such information and such information has not been independently verified by SEI.
Neither SEI, nor its affiliates provide tax advice. Please note that (i) any discussion of U.S. tax matters contained in this communication cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor.
Information provided by SEI Investments Management Corporation, a wholly owned subsidiary of SEI Investments Company. Neither SEI nor its subsidiaries is affiliated with your financial advisor.