MACRO OUTLOOK AND UPDATE. Deciphering the markets mixed messages

Transcription

1 MACRO OUTLOOK AND UPDATE Deciphering the markets mixed messages

2 AGENDA Mixed Signals Macro the good, the bad and the ugly Signals from the Bond Market Outlook for Risk Assets Summary Q&A 2

3 THE GOOD NEWS

4 THE GOLDILOCKS ECONOMY

5 STRONG ECONOMIC GROWTH The US continues to show robust economic growth Tax reform, corporate earnings and modest inflation have all been tailwinds for 10 successive increases in quarterly GDP US Gross Domestic Product Q115 Q215 Q315 Q415 Q116 Q216 Q316 Q416 Q117 Q217 Q317 Q417 Q118 Q218 Q *Source: St. Louis Fed, 12/31/18 5

6 STRONG PRIVATE INVESTMENT After significant declines in 2015 and 2016 Fixed Private Investment has continued to increase throughout 2017 and US Private Fixed Investment Q115 Q215 Q315 Q415 Q116 Q216 Q316 Q416 Q117 Q217 Q317 Q417 Q118 Q218 Q *Source: St. Louis Fed, 12/31/18 6

7 LOW UNEMPLOYMENT Strong economic growth has continued to reduce unemployment which now stands at a 50 year low of 3.9% Even though unemployment ticked up in December it was primarily because of more workers entering the workforce US Unemployment Q115Q215Q315Q415Q116Q216Q316Q416Q117Q217Q317Q417Q118Q218Q318Q *Source: St. Louis Fed, 12/31/18 7

8 MODEST INFLATIONARY PRESSURES Despite strong economic growth and low unemployment, inflation remains in check and is still below the Fed s state 2% target US Personal Consumption Expenditures (PCE) *Source: St. Louis Fed, 12/31/18 8

9 CONSUMER CONFIDENCE IS AT MULTIYEAR HIGHS Not surprisingly, the goldilocks economy has created massive positive consumer sentiment Consumer confidence is currently at a 15 year high heading into what is expected to be a very robust holiday spending season This is the narrative that has fueled the markets higher Consumer sentiment is at a 15 year high *Source: St. Louis Fed, 12/31/18 9

10 IF EVERYTHING IS SO GREAT

11 TRADITIONAL ASSETS DEVELOPED EQUITIES 2018 was the worst year for risk asset since 2008 The average return for all 17 Developed Markets Countries was -14.2% *Source: Bloomberg, 12/31/ % -25.3% -26.9% Developed Market Equity Returns % -5.5% -7.8% -9.1% -9.4% -12.0% -12.8% -12.9% -13.1% -14.2% -14.2% -15.0% -16.2% -17.2% -17.8% -30% -25% -20% -15% -10% -5% 0% 5% 10% United States Israel Hong Kong Switzerland Singapore Australia France Japan Netherlands AVERAGE United Kingdom Denmark Spain Canada Italy Germany Ireland Belgium 11

12 TRADITIONAL ASSETS EMERGING EQUITIES While average returns in emerging markets were similar to developed markets (-14.4% vs -14.2%), median returns were actually better (-12.9% vs %) More than 1/3 of Emerging Markets were positive in Q4 and average returns were - 4.2% vs % in developed markets *Source: Bloomberg, 12/31/ % -41.4% Emerging Market Equity Returns 2018 YTD* -24.8% -0.5% -0.7% -4.4% -6.1% -7.3% -9.2% -11.5% -12.9% -14.4% -15.5% -16.5% -18.9% -19.7% -20.0% 1.6% -45% -35% -25% -15% -5% 5% Peru Brazil Russia Czech Republic Hungary India Indonesia Colombia Poland AVERAGE Mexico Phillipines China Chile South Korea South Africa Greece Turkey 12

13 TRADITIONAL ASSETS FIXED INCOME Tough environment for Fixed Income with all sectors flat or down in 2018 except for Municipal Bonds Muni Bonds Fixed Income Returns YTD 1.6% BarCap Agg 0.0% US Corporate Bonds 0.0% US High Yield Bonds -2.1% Int'l Developed Bonds -2.3% Emerging Market Bonds -4.3% -12% -7% -2% 3% *Source: Bloomberg, 12/31/18 13

14 60/40 RETURNS 2018 was the worst year for 60/40 portfolios since 2008 After years of above average returns, 60/40 portfolios suffered in % 10.0% 5.0% US 60/40 Returns 6.5% 6.2% 9.5% 10.9% 0.0% -5.0% -2.3% -10.0% Year 5 Year 10 Year *Source: Bloomberg, 12/31/18. US 60/40 is represented by 60% S&P 500 and 40% Barcap Aggregate Bond Index. 14

15 THE BAD NEWS

16 16 THE BAD NEWS

17 THE BAD NEWS A TALE OF TWO MARKETS Tariff escalation was announced on March 22, 2018 In the short-term, the prospect of a trade war has had a much more profound impact on Chinese stock markets than in the US 60% 50% 40% 30% 20% S&P 500 vs. China A Share Index 3/22/16-3/22/18 34% 33% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% S&P 500 vs. China A Share Index 3/22/18 11/30/18 6% -27% Initially the thought was that this was isolated to China, but. 10% 0% S&P 500 China A Share S&P 500 China A Share *Source: Bloomberg, 12/31/18 17

18 THE BAD NEWS TRADE WAR STARTING TO IMPACT US Since the end of November foreign markets performance has started to converge with US performance Lower rates, weaker dollar and slowing growth in the US have all contributed to a convergence in returns 5% 0% -5% -10% -15% -20% S&P 500 vs. China A Share Index 11/30/18 12/24/18 China A Share S&P 500-4% -15% 5% 3% 1% -1% -3% -5% -7% -9% -11% -13% -15% US vs. Emerging Market Performance Q Emerging Markets S&P 500-4% -14% *Source: Bloomberg, 12/31/18. Emerging Market performance is average of 17 MSCI Emerging Markets. 18

19 THE BAD NEWS POTENTIAL TRADE WAR A protracted trade war could have a far wider impact as many economies are dependent upon foreign demand 19

20 THE BAD NEWS SLOWING GROWTH Rising rates, strong dollar and trade war are weighing heavily on emerging economies Everything is interconnected trade, rates and ultimately the dollar G-20 Developed Economies G-20 Emerging Economies May Estimates September Estimates May Estimates September Estimates *Source: St. Louis Fed, 12/31/18 20

21 THE BAD NEWS The impact of reduced trade will have a larger effect as growth slows Eurozone GDP Q116 Q216 Q316 Q416 Q117 Q217 Q317 Q417 Q118 Q218 Q318 Q418 EST Q119 EST Q219 EST Japan GDP Q116 Q216 Q316 Q416 Q117 Q217 Q317 Q417 Q118 Q218 Q318 Q418 EST Q119 EST Q219 EST US GDP Q116 Q216 Q316 Q416 Q117 Q217 Q317 Q417 Q118 Q218 Q318 Q418 EST Q119 EST Q219 EST *Source: St. Louis Fed, 11/30/18 21

22 THE RESULT IS.A LOT OF NOISE Increase in volatility has made it easier for investors to get whipsawed as reversals have happened very quickly 60% 40% 20% Performance of Crude Oil 26% 27% 60% 40% 20% Performance of Tech Stocks 22% 14% 0% 0% -20% -20% -40% -40% -24% -60% 12/31/17-10/3/18-44% 10/3/18-12/24/18 12/24/18-1/18/19-60% 12/31/17-10/3/18 10/3/18-12/24/18 12/24/18-1/18/19 *Source: Bloomberg. Crude Oil is referenced by WTI Spot Price. Technology stocks are referenced by the S&P 500 Technology Index. Data as of 1/18/19. 22

23 THE RESULT IS.A LOT OF NOISE Fixed Income Markets have had their own share of volatility US 10 Year Treasury Note Yield 94% of US Bond Managers lost money as rates rose from 2.86% June 29 to 3.25% of November 8 3% 3% 3% 3% 3.06% 2.86% 3.24% 2.78% 3% 2% 2.41% 2.55% 2% 2% 12/31/17 5/22/2018 6/26/18 11/8/18 1/3/19 1/18/19 *Source: Bloomberg. Data is based on the US 10 Year Treasury Yield. Data as of 1/18/19. 23

24 FIXED INCOME OUTLOOK

25

26 26 The Year of Volatility and a Year to Stay Active For Institutional Investor Use Only/ Not for Public Viewing or Distribution

27 27 7 Themes for 2019 We expect 2019 to be a year of heightened volatility and uncertainty. We are focused on: 1. Interest Rates 2. The Fed 3. Credit 4. Curves 5. CEO / CFO Behavior 6. Washington 7. Active vs. Passive For Institutional Investor Use Only/ Not for Public Viewing or Distribution

28 28 What does this mean for investors? promises to be another volatile year in the markets with greater uncertainty and more severe outcomes. 2. With greater uncertainty comes significant dispersion and differentiation, especially in the credit markets. 3. We are in a bond picker s market. 4. The core of our thesis around heightened volatility in 2019 rests on the view that we are coming off a period of money being priced below its natural rate. 5. With these ongoing changes will come heightened volatility and uncertainty but, most importantly, new valuations and repricing of risk. 6. Active management, focusing on resiliency and the ability to adapt to the volatility will be required. For Institutional Investor Use Only/ Not for Public Viewing or Distribution

29 29 Interest Rates Similar to 2018, we believe that the front end offers some of the most compelling risk-adjusted returns. The long-end should be monitored closely for opportunities. The inflation outlook will prove to be challenging for many investors as the inflation rebasing effects come into play in the back half of this year. Ultimately the economic outlook and the health of the consumer will garner the greatest focus and be the key driver of risk assets. Growth may prove to be on more solid footing than many expect. Source Smith Capital Investors, Bloomberg as of Jan 22, 2019 For Institutional Investor Use Only/ Not for Public Viewing or Distribution

30 30 The Fed The Fed will be a source of calm this year. The marketplace will realize that they are strongly committed to their core mandates price stability and full employment. We are watching spread relationships closely to gauge market sentiment and consensus views. We expect there will be opportunities around this spread relationship throughout We can not lose sight of the balance sheet reduction path and the impact on markets. Source: WSJ Sept. 19, 2017 For Institutional Investor Use Only/ Not for Public Viewing or Distribution

31 31 Credit Investment Grade High Yield Credit markets have grown in size and depth. With the re-leveraging we have seen an explosion in the quantity of credit and a deterioration of quality. We would not be surprised to see a series of downgrades and acceleration of defaults in the credit markets in There are going to be some great winners in the credit space and some unbelievable losers For Institutional Investor Use Only/ Not for Public Viewing or Distribution

32 32 Curves 2 / 10 / 30 Long / Short Credit How much risk is one willing to take per unit of return? Flat curves require a different perspective on risk and reward. Yield-seekers must be very mindful of the drawdown risk during periods of flat curves. Minimal yield pickup for extending in either Treasuries or credit comes from very diverse future expectations Downside risk become an even more important consideration during these periods. For Institutional Investor Use Only/ Not for Public Viewing or Distribution

33 33 CEO / CFO Behavior Complacent buyers of credit have fueled more aggressive behaviors by management teams and greater complacency in board rooms across America. Many leadership teams will look back on the massive amounts of capital committed to share repo and some of the deals done with regret and most likely a lot of revisionist history around shareholder value creation. For Institutional Investor Use Only/ Not for Public Viewing or Distribution

34 34 The Trump, Pelosi and Schumer Reports The implication of the growing debt load in our great country concerns us and creates increased instability and possibly lower levels of confidence in the system. This promises to be an interesting year, one where politics probably rattle markets more than concerns around economic conditions. We are going to learn the two are very intertwined in For Institutional Investor Use Only/ Not for Public Viewing or Distribution

35 35 Active versus Passive The sell-off in rates early in 2018 validated concerns around the interest rate sensitivity of the index. Furthermore, the rally in rates in Q coupled with the spread widening in credit showed the impact of overall credit growth in the market. We believe investors will continue to see the importance and value of active fixed income management, especially as it relates to capital preservation. For Institutional Investor Use Only/ Not for Public Viewing or Distribution

36 36 What Could Go Right? We are very aware of what can go wrong this year and expecting a volatile year in front of us. An overwhelming bearish sentiment has escalated over the last couple of months. While rooted in a capital preservation mindset, we are asking ourselves What can go right? The consumer sentiment is strong: lower prices at the pump, full employment and higher wages. The Fed is listening to the market and committed to transparent communication around their balance sheet. A modest reprieve in mortgage rates will help stabilize housing. Progress made on trade? Some of the near-term fears abate? We know it is not going to be like 2018 and we see significant hurdles for the market to overcome in the near future. More importantly, we do not have a massive stimulus to lift us back to a 3% growth, but a few things clicking will keep us very much in the game at a 2% pace of growth which creates new opportunities. It is easy to lose sight of what could go right For Institutional Investor Use Only/ Not for Public Viewing or Distribution

37 ATTRACTIVE INVESTMENT THEMES RISK ASSETS

38 ATTRACTIVE THEMES Based on current valuations certain risk assets appear to be attractively priced Emerging Markets Health Care Stocks Real Assets 38

39 REAL ASSETS In addition to positive fundamentals and demographic trends, real assets may be more attractively priced than traditional assets such as stocks and bonds 100% 75% Current Prices vs All Time High January 18, % 93% 99% 25% 63% 37% 0% US Stocks US Bonds MLPs Commodities Source: Bloomberg. Midstream represented by the Alerian Energy Infrastructure Index. MLPs represented by the Alerian MLP Infrastructure Index. Commodity returns represented by the Bloomberg Commodity Index. Equity returns represented by the S&P 500 and Bonds represented by the Barcap Aggregate Bond Index. 39

40 MLP FUNDAMENTALS INTACT // US oil and natural gas production near record highs and growing rapidly // US expected to be a net energy exporter in US Oil Production US Natural Gas Production 1 40 Source: Energy Information Administration, as of January 31, 2018

41 MLP YIELDS ARE WIDER THAN AVERAGE Average historical spread between MLPs and Treasuries is 424 bps current spread is in the 92 nd percentile of observations over the past decade 25% 20% 15% 10% 5% Time Spent in Range 3.3% 15.4% 11.6% Yield Spread Distribution: AMZI versus US 10-year Treasury (March 31, December 31, 2018) 17.0% 13.8% 11.9% 8.8% 6.8% Current Spread: 614 bps 2.4% 1.6% 1.4% 1.6% 1.4% 3.2% *Source: Alerian, Bloomberg, 12/31/18 0% 2.01% % 2.51% % 3.01% % 3.51% % 4.01% % 4.51% % 5.01% % 5.51% % Yield Spread Range 6.01% % 6.51% % 7.01% % 7.51% % 8.01% >=8.0% % 41 41

42 SUMMARY The market and economy continue to deliver mixed messages to investors Despite strong economic growth, low unemployment and modest inflation, forward looking headwinds have spooked the markets A strong dollar, pending trade war, rising rates and slowing global growth have all created uncertainty As a result, traditional assets have suffered 2018 was the worst year for a 60/40 portfolio since 2008 Active security selection and duration / credit exposure may be a critical component going forward in Fixed Income Emerging Markets and Real Assets are attractively priced and may be additive going forward Don t lose sight of what could GO RIGHT! 42 ALP /31/2019

43 43 Important Disclosures The opinions and views expressed are as of the date published and are subject to change without notice. Information presented herein is for discussion and illustrative purposes only and should not be used or construed as financial, legal, or tax advice, and is not a recommendation or an offer or solicitation to buy, sell or hold any security, investment strategy, or market sector. No forecasts can be guaranteed. Any investment or management recommendation in this document is not meant to be impartial investment advice or advice in a fiduciary capacity, and is not tailored to the investment needs of any specific individual or category of individuals. If you are an individual retirement investor, contact your financial advisor or other fiduciary unrelated to Smith Capital Investors about whether any given investment idea, strategy, product or service described herein may be appropriate for you. Opinions and examples are meant as an illustration of themes, are not an indication of trading intent, and are subject to change at any time due to changes in market or economic conditions. There is no guarantee that the information supplied is accurate, complete, or timely, nor are there any warranties with regards to the results obtained from its use. It is not intended to indicate or imply that any illustration/example mentioned is now or was ever held in any portfolio. Past performance is not a guarantee or a reliable indicator of future results. Investing in a bond market is subject to risks, including market, interest rate, issuer, credit, inflation, default, and liquidity risk. The bond market is volatile. The value of most bonds and bond strategies are impacted by changes in interest rates. Bond investments may be worth more or less than the original cost when redeemed. The return of principal is not guaranteed, and prices may decline if, among other things, an issuer fails to make timely payments or its credit strength weakens. High yield or junk bonds involve a greater risk of default and price volatility and can experience sudden and sharp price swings. Please consider the charges, risks, expenses and investment objectives carefully before investing. Please see a prospectus, or, if available, a summary prospectus containing this and other information. Read it carefully before you invest or send money. Investing involves risk, including the possible loss of principal and fluctuation of value. There is no guarantee that any particular investment strategy will work under all market conditions or are suitable for all investors. Investors should consult their investment professional prior to making an investment decision. All indices are unmanaged. You cannot invest directly in an index. Index or benchmark performance presented in this document does not reflect the deduction of advisory fees, transaction charges, and other expenses, which would reduce performance. This material may not be reproduced in whole or in part in any form, or referred to in any other publication, without express written permission from Smith Capital Investors. Smith Capital Investors, LLC is an investment adviser registered with the U.S. Securities and Exchange Commission. For Institutional Investor Use Only/ Not for Public Viewing or Distribution