2018: YEAR OF THE BOND MARKET

Transcription

1 Quarterly Update January : YEAR OF THE BOND MARKET Dear Clients and Friends: Looking back, 2017 will be remembered as the year of technology and equity momentum with the latter factor returning +38%, it s highest since Looking forward we believe 2018 will be a year of the bond market with the economy s transition from post -crisis low growth to synchronized global growth. The big question; however, will be whether the transition is a smooth one or not considering the Federal Reserve is raising interest rates and exiting quantitative easing just as the supply of new Treasury issuance is set to grow and foreign buyers may reduce their purchases. While the economy looks to be in good shape, we will look to the bond and credit markets as key indicators of future market health Will Be The Year Of The Bond Market Over the next twelve months the global economy will hopefully make a smooth transition from low growth to normal growth and from quantitative easing to monetary normalization. The fear is that the transition will not be smooth if growth, employment or inflation is stronger than anticipated and the Federal Reserve raises short -term interest rates more aggressively in response or the market pushes up longer-term rates. We have already seen the yield on the 10 -year Treasury rise to 2.55% and Bill Gross, affectionately known by many as the king of bonds, declared the end to the 25 -year bond bull market. The implications of the economic transition, global growth and the response by the Fed are significant. If growth or inflation is too high then rates will rise, central banks will drain liquidity, credit spreads will widen and equity multiples will contract. Too Much Of A Good Thing? Around the world there is growing sense of synchronization with growth improvements in manufacturing and employment in the U.S., Germany, France, U.K., Canada, and Japan as well as Brazil, Russia, and China. Will such growth lead to an upside surprise in inflation which markets appear to not be expecting? Bullish On Active Managers As the world s central banks raise interest rates, exit quantitative easing and end widespread asset purchases we believe active management will again add value similar to that seen in the early/mid 2000 s. We will maintain an allocation to passive indexes/etfs but believe active managers like hedge 1 funds or quantitative strategies will add significant value. In support of this statement the stock -picking

2 Quarterly Update January 2018 environment is fertile and our active managers have added quite a lot of value in 2017, which we forecast to continue. Our Base Investment Case Remains The Same For now our base investment case remains the same, i.e. earnings are solid, single stock correlations are low, interest rates are still low, inflation is modest, and liquidity remains widespread all positive for equities and stock-picking hedge funds in particular. As noted recently by Jeremy Grantham of GMO we may very well enter a melt up phase in the stock market a phase that can generate huge returns and can go on for years before succumbing to a sudden and sharp market correction. While we do not see signs of a recession we are overdue for a short -term market correction. For now it is steady as she goes. Monthly Data Starting this month we will send an of fairly detailed market data including returns and yields, for your reference. The data will cover a variety of asset classes, sectors, geographies, and factors. We hope that you find it useful. Please see page 3 for the data table. Warm regards, Your Spruce Team 2

3 Quarterly Update January 2018 Bond Market Returns Barclays U.S. Aggregate Barclays 1-10-Year Municipal Barclays High-Yield Citi WGBI ex-u.s. (USD) J.P. Morgan EMBI Global Equity Markets Returns Date MTD QTD YTD 1-YR 2-YR 3-YR 5-YR 10-YR 0.46% 0.64% 0.30% 0.08% 0.63% 0.39% -0.22% 0.47% 1.57% 0.54% 3.54% 3.49% 7.50% 10.33% 9.32% 3.80% 3.52% 7.52% 10.52% 9.36% 3.22% 1.69% 12.26% 5.89% 9.75% 2.30% 1.97% 6.35% 2.03% 6.82% 2.08% 2.02% 5.78% -0.34% 3.76% 4.04% 3.57% 8.04% 2.45% 7.06% Date MTD QTD YTD 1-YR 2-YR 3-YR 5-YR 10-YR 1.65% 5.84% 24.62% 24.57% 15.53% 9.47% 11.56% 5.18% 1.11% -0.40% 0.55% 1.90% 2.46% -0.55% 2.25% 5.27% 2.11% 2.13% -0.44% -6.06% 4.74% -0.11% 6.64% 3.34% 8.61% 8.43% 9.93% 1.57% 6.17% 6.22% 7.16% 7.09% 3.30% 0.23% -0.95% 2.37% 21.83% 14.65% 34.26% 22.03% 22.82% 21.77% 12.98% -0.89% 23.98% 24.01% 10.69% 12.05% -6.52% 9.27% 21.27% 14.14% 33.21% 22.29% 21.79% 21.33% 12.42% -1.17% 23.54% 23.20% 11.75% 11.43% -6.13% 10.25% 15.83% 16.68% 22.87% 21.27% 13.05% 8.10% 8.11% 12.14% 21.02% 19.27% 6.21% 13.38% 6.65% 8.53% 10.85% 9.52% 16.24% 12.50% 11.81% 7.13% 6.69% -1.63% 11.11% 8.51% NA 5.94% -9.58% 6.31% 16.18% 14.59% 18.45% 17.11% 16.94% 16.67% 11.69% 1.85% 16.20% 11.30% NA 12.78% 0.27% 10.13% 8.42% 8.63% 10.06% 3.02% 12.70% 10.06% 8.71% 0.18% 8.20% 5.21% NA NA 6.00% 7.81% 1.62% 1.52% 0.72% 4.27% 2.26% 8.52% 25.62% 26.24% 24.39% 26.27% 27.35% 24.17% 12.42% 11.63% 13.24% 7.92% 6.87% 11.71% 8.36% 7.99% 11.38% 2.42% 1.91% 3.52% 3.64% 2.84% 4.52% 1.91% 7.50% 8.41% -2.24% 7.62% 37.75% 43.26% 24.15% 54.33% 38.37% 44.26% 23.79% 55.48% 23.56% 23.41% 26.45% 24.49% 9.41% 11.40% 4.12% 12.95% 4.73% 8.30% -2.93% 10.22% 2.01% 3.98% -1.51% 3.33% 0.58% 1.62% 1.06% 6.83% 7.45% 3.21% 34.01% 29.02% 15.36% 34.01% 29.02% 15.36% 17.98% 16.41% 10.85% 12.86% 11.76% 4.03% 14.28% 13.47% 4.74% 6.11% 8.11% 0.18% Date MTD QTD YTD 1-YR 2-YR 3-YR 5-YR 10-YR 3.04% 2.11% -5.16% 6.77% 2.63% 3.12% 10.25% 12.68% 16.14% 10.12% 13.73% 12.48% 16.97% 10.97% 27.61% 3.07% 2.88% 4.19% -3.78% -4.81% -8.02% -5.28% 4.45% -4.52% World MSCI All-Country World US S&P 500 Russell 2000 S&P Technology Sector S&P Financial Sector S&P Consumer Discretionary S&P Healthcare S&P Consumer Staples S&P Energy S&P Industrial S&P Materials S&P Real Estate S&P Utilities Alerian MLP NAREIT International MSCI EAFE MSCI Europe MSCI Japan Emerging MSCI Emerging Market Free MSCI Emerging Market Asia MSCI Emerging Market LatAm MSCI China Factors MSCI ACWI Momentum MSCI ACWI Quality MSCI ACWI Dividend Real Asset Markets Returns DJ-UBS Commodity Gold WTI Crude Oil Please note YTD (calendar 2017) and 1-Year (last 365 days) differ by a day and therefore have slightly different returns. 3

4 Date Month End Quarter End Year End Year Ago 2-YR Ago 3-YR Ago 5-YR Ago 10-YR Ago Global Bond Yields US U.S. Three-Month T-Bill 1.25% 1.04% 0.50% 0.46% 0.23% 0.03% 0.01% 3.10% U.S. 10-Year Treasury Note 2.42% 2.33% 2.45% 2.49% 2.32% 2.22% 1.73% 4.11% Germany Three-Month T-Bill 0.24% 0.24% 0.24% 0.24% 0.24% 0.24% 0.77% 4.03% Germany 10-Year Treasury Note 0.37% 0.46% 0.11% 0.08% 0.63% 0.55% 1.31% 4.33% Japan Japan One-Month T-Bill -0.17% -0.18% -0.17% -0.17% 0.01% 0.03% 0.09% 56.30% Japan 10-Year Treasury Note 0.04% 0.06% 0.05% 0.04% 0.25% 0.33% 0.79% 1.50% Switzerland SUI Three-Month Eurocurrency Yield -0.75% -0.75% -0.80% -0.80% -0.65% -0.30% -0.05% 2.75% SUI 10-Year Treasury Note -0.11% -0.01% -0.20% -0.23% -0.08% 0.32% 0.46% 2.97% UK UK Three-Month T-Bill 0.35% 0.22% 0.01% 0.01% 0.47% 0.39% 0.31% 5.31% UK 10-Year Treasury Note 1.36% 1.40% 1.24% 1.24% 1.92% 1.80% 1.81% 4.55% Month Quarter Year Year 2-YR 3-YR 5-YR 10-YR Credit Spreads Date End End End Ago Ago Ago Ago Ago Barclays AAA Credit 0.24% 0.25% 0.35% 0.35% 0.30% 0.19% 0.28% 0.97% Barclays BBB Credit 1.28% 1.31% 1.60% 1.60% 2.24% 1.76% 1.80% 3.08% Barclays CCC Credit 6.18% 6.47% 8.07% 8.04% 13.43% 8.14% 8.03% 11.35% Barclays High-Yield 0.30% 0.47% 7.50% 7.52% 12.26% 6.35% 5.78% 8.04% J.P. Morgan EMBI Global 0.63% 0.54% 9.32% 9.36% 9.75% 6.82% 3.76% 7.06% Currencies Date MTD QTD YTD 1-YR 2-YR 3-YR 5-YR 10-YR Euro (EUR) 0.85% 1.62% 14.15% 14.44% 4.85% -0.40% -1.90% -2.02% Japanese Yen (JPY) -0.66% -0.08% 3.53% 3.37% 3.42% 2.29% -5.23% 0.04% Swiss Franc (CHF) 0.77% -0.71% 4.30% 5.05% 0.95% 0.45% -1.29% 1.48% Source: Bloomberg, ThomsonReuters Please note YTD (calendar 2017) and 1-Year (last 365 days) differ by a day and therefore have slightly different returns. DISCLOSURES This presentation does not constitute an offer to sell, or a solicitation of an offer to buy, any interest in any investment vehicle, and should not be relied on as such. Nor does this document, or any attachment hereto disclose the risks or terms of an investment in any investment vehicle managed by Spruce or any of its affiliates. Solicitations can be made only with the applicable Fund s offering documents and only to qualified persons. For accredited investors with $5+ million only. These materials are not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to local law or regulation. Distribution of this information to any person other than the person to whom this information was originally delivered and to such person s advisors is unauthorized and any reproduction of these materials, in whole or in part, or the disclosure of any of the contents, without the prior written consent of Spruce Investment Advisors, LLC in each such instance is prohibited. We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. The opinions, estimates, and investment strategies and views expressed in this document are based upon current market conditions and/or data and information provided by unaffiliated third parties and are subject to change without notice. Certain information herein constitutes forward looking statements. Actual events or performance may differ materially from those contemplated by such forward-looking statements. Disclosure Required Under IRS Circular 230: Spruce Investment Advisors, LLC does not offer tax advice and any information contained in this communication, including any attachments, was not intended or written to be used, and cannot be used, for the purpose of avoiding federal tax-related penalties or promoting, marketing or recommending to another party any transaction or matter addressed herein. The indices, blends, and benchmarks (collectively, the Blends ) shown are strictly for the information purposes of comparison between portfolio performance and the information contained herein and these Blends. There is no representation that such Blend is an appropriate benchmark for such comparison. The Blends are composed of widely recognized indices of market activity based upon the aggregate performance of a selected portfolio of publicly traded common stocks, debt securities, commodities, currencies, or other managed funds. The performance of theses Blends reflects the reinvestment of dividends and other distributions (e.g., total return ). The Blends are not subject to any of the fees and expenses to which any Fund or Strategy would be subject. The Blends have been selected as general indicators of market health, despite the lack of similarity of their underlying components to any Fund or Strategy. The volatility of Blends may be materially different from the performance of Spruce. In addition, Spruce s recommendations may differ significantly from the securities that comprise the Blends. Each Fund or Strategy will invest in other market investment vehicles and will not attempt to replicate the performance of any of the Blends. You cannot invest directly in an index. 4

5 Quarterly Update January Year In Review In retrospect 2017 turned out to be pretty simple with equities driving broad-based performance. Both passive and active funds performed well, as did international and domestic managers. If you outperformed, you likely had an over-allocation to large cap technology or momentum, both of which included the popular FAANG stocks like Facebook and Amazon. If you underperformed, you probably owned small cap, value, energy, or bonds. Either way strong earnings, improved growth, low interest rates, low inflation, and historically low volatility-levels were wonderful for equities. While the global economy is clearly approaching normalization it will only encourage global central bankers to shift from quantitative easing to quantitative tightening. Make no mistake that we are in the latter stages of the equity bull market, although late cycle gains can go on for several years. 5

6 2017 Was All About Equity Momentum And Not Value (Again) 2017 Was Also About Strong Earnings Growth Low Economic Volatility Helped Drive Up Equity Prices 6

7 S&P 500 Index Returns All sectors performed inline with each other except for two outliers; technology which outperformed and energy which declined. 2017: Tech = Yes, Telecom and Energy = No Over a longer period of time we see that technology, healthcare and consumer discretionary were the sector outperformers, with energy again lagging due to the energy downturn in 2014 and underperformance in Since 2010: Tech, Healthcare and Consumer Source: Bloomberg, Top Chart Dates: Dec 30, 2016 December 28th, 2017; Bottom Chart Dates: Dec 31, 2010 December 28th,

8 Global Index Returns: On a global basis 2017 was about emerging markets and China both due to ample earnings expansion. In China technology again led the way with stocks such as Tencent and Alibaba gaining 114% and 96% respectively. Global 2017: All About Earnings Growth In China and EM Since 2010; however, it was the United States and Japan that led the way with America benefitting from equal measure multiple expansion and earnings growth. Japan, interestingly, gained almost exclusively on earnings growth thanks to the monetary, fiscal and structural reform policies of Prime Minister Shinzo Abe. Global since 2010: U.S. and Japan Profits Lead, While China and EM Lags Source: Bloomberg, Top Chart Dates: Dec 30, 2016 December 28th, 2017; Bottom Chart Dates: Dec 31, 2010 December 28th,

9 2018 Looking Forward Low Correlations and Late Stage Argue for Active Managers As long as the Federal Reserve does not surprise the markets, inflation remains muted, longer-term interest rates stay under control and corporate earnings growth remains solid, we would expect to see more equity gains in Morgan Stanley s Cross Asset Team summarized the outlook nicely. They expect: Solid Macro Outlook Solid macro environment but complex handoff : Global growth remains steady in 2018, and inflation rises towards target. But slowing US and China growth mean a tricky handoff to the rest of the world. Magnitude of Movements In Single Stocks On The Rise UST Curve Flattens: Morgan Stanley economists expect three Fed hikes for As the Fed hikes, 2 year rates rise while 10 year and 30 year rates fall. Strategists expect to have a completely flat US Treasury curve by 3Q18. Late-cycle, low-correlation environment: Low macro and micro correlations confirm we re late cycle. The last time the team saw readings this low was losers; however, that difference has come back with a vengeance. This makes complete sense to us as companies like Amazon are generating high growth in revenues and U.S. Stocks Are More Than One Standard Deviation Expensive Compared To market share while retailers like Macys or Nordstrom are suffering greatly. Rest of the World We continue to believe that low correlations argue for active managers including quantitative and fundamental stock picking funds. Low correlations and high equity dispersion (some stocks are more volatile than others) rewards managers for picking winning companies while shorting the losing companies. For several years there was little performance difference between winners and As the rest of the world follows the path of the U.S. and resumes more normal growth we see greater opportunity for returns in non-u.s. stocks due to the wide valuation dispersion between domestic and international stocks. The chart below shows international stocks, which were hammered in post-2008 environment relative to the U.S., trading at more than one standard deviation below that of domestic stocks. In the short term, i.e. any period under three 9

10 periods. The following chart suggests international stocks should generate much higher returns over the next decade than U.S. stocks. U.S. Stocks Are Quite Expensive Relative To International For now financial conditions remain loose in spite of the recent rise in interest rates, but as the global economy achieves escape velocity the worlds central banks are sure to increase interest rates, and slow or stop their buying of bonds, mortgages and ETFs. What effect this will have on risk assets is of primary concern for As our market views have matured we have added and/or are in the process of adding the following actively managed funds to our client portfolios as complements our ETF investments. We expect these managers to add value through improved returns, risk reduction, greater diversification, higher income or a combination thereof. Long-Biased Equities: Financial Conditions Remain Loose Quantitative manager - U.S. all cap stocks Quantitative manager - global all cap stocks Fundamental emerging markets equity manager London Hedge Funds: Inflation Normalization Paves Way For Rate Increases Emerging market macro fund European financials long short equity Healthcare long short equity Technology long short equity aggressive Technology long short equity lower volatility Small cap long short equity lower net Private Investments Middle market credit/distressed Oil & Gas Middle market healthcare 10

11 Should rates continue to increase Societe Generale (SocGen) forecasts a possible -22% decline in equities if the 10-year Treasury yield increases to 3.0% (it has recently risen to 2.55%). We should point out that their forecast of a -7% equity decline should yields hit 2.5% has yet to materialize. On balance higher than expected rates are a risk factor for 2018 and Chart: Higher Rates = Lower Equities? Possible Equity 2018 Losses Short-term momentum-driven correction, temporary decline of 5 to 15% Trade friction with China, or geopolitical risk with North Korean, Iran or Russia Oil rises above $80-90 per barrel Federal Reserve Bank intends to raise short-term interest rates more than expected or warranted Inflation surprises and long-term rates rise more than expected Summary In summary we believe the global expansion is real and diverse, and will be a tailwind for equity assets focused on Market Outcomes While our current outlook is positive we should consider both good and bad outcomes for 2018: Possible 2018 Equity Market Gains Sustained corporate earnings growth (Don t expect more multiple expansion in fact multiples may contract earnings will have to drive gains) Further industry deregulation Dollar continues to weaken boosting exports Fewer than three interest rate hikes global and emerging markets. We are increasing our allocation to both active managers and alternative investments at the expense of passive ETFs in the hope of adding idiosyncratic returns and additional risk management capabilities. The largest downside risk will be central banks as they embark on a path of tightening and we will watch the bond and credit markets for signs of concern. Other risks include inflation and a spike in oil prices. A short-term market correction of 5-15% can occur at any time but it would not likely be indicative of an impending recession. 11

12 DISCLOSURE This presentation does not constitute an offer to sell, or a solicitation of an offer to buy, any interest in any investment vehicle, and should not be relied on as such. Nor does this document, or any attachment hereto disclose the risks or terms of an investment in any investment vehicle managed by Spruce or any of its affiliates. Solicitations can be made only with the applicable Fund s offering documents and only to qualified persons. For accredited investors with $5+ million only. These materials are not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use is contrary to local law or regulation. Distribution of this information to any person other than the person to whom this information was originally delivered and to such person s advisors is unauthorized and any reproduction of these materials, in whole or in part, or the disclosure of any of the contents, without the prior written consent of Spruce Investment Advisors, LLC in each such instance is prohibited. This presentation contains certain forward-looking statements based on current expectations, estimates and projections about the industry and markets in which Spruce will operate, as well as Spruce s beliefs and assumptions. These statements involve certain risks, uncertainties and assumptions which are difficult to predict. Consequently, such statements cannot be guarantees of future performance and actual outcomes and returns may differ materially from statements, goals and objectives set forth herein. Spruce may discuss certain specific securities during the call in order to give examples of our equity investment strategy. References to securities are not endorsements of such securities and there is no guarantee that will continue to hold any positions. Client portfolios are subject to change at any time at Spruce s discretion depending on prevailing market conditions, among other things. This presentation contains certain forward-looking statements based on current expectations, estimates and projections about the industry and markets in which Spruce will operate, as well as Spruce s beliefs and assumptions. These statements involve certain risks, uncertainties and assumptions which are difficult to predict. Consequently, such statements cannot be guarantees of future performance and actual outcomes and returns may differ materially from statements, goals and objectives set forth herein. Spruce may discuss certain specific securities during the call in order to give examples of our equity investment strategy. References to securities are not endorsements of such securities and there is no guarantee that will continue to hold any positions. Client portfolios are subject to change at any time at Spruce s discretion depending on prevailing market conditions, among other things. We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. The opinions, estimates, and investment strategies and views expressed in this document are based upon current market conditions and/or data and information provided by unaffiliated third parties and are subject to change without notice. Certain information herein constitutes forward looking statements. Actual events or performance may differ materially from those contemplated by such forward-looking statements. Past performance is not indicative nor a guarantee of comparable future results. Performance indicated includes the reinvestment of all dividends, interest, income, and profits. The investments discussed herein may fluctuate in price or value. Investors may get back less than they invested. Spruce may compensate employees for new advisory business. This compensation is based on a percentage of the advisory fees paid to Spruce by the client. The client does not incur any additional fees as a result of this arrangement. All fees are subject to negotiation. Investors in the Partnership must be (i) accredited investors as defined under the Securities Act of 1933, as amended, and (ii) qualified purchasers or knowledgeable employees as defined under the Investment Company Act of 1940 and the rules promulgated thereunder. Interests may not be purchased by non-resident aliens, foreign corporations, foreign partnerships, foreign trusts or foreign estates, all as defined in the Internal Revenue Code of 1986, as amended, or by entities that are exempt from federal income tax. The General Partner may decline to admit an investor even if it meets such suitability requirements. Prospective investors will be furnished with subscription documents and will be required to complete and return them to the General Partner prior to admission to the Partnership. Unless stated otherwise performance is quoted as an estimate gross of Spruce s fees but net of all underlying fund or manager fees. There are no fees for indexes. This material from Spruce Investment Advisors, LLC is intended only for the individual or entity to which it is addressed. This material may contain information that is privileged, confidential and exempt from disclosure under applicable law. If you are not the intended recipient, you are hereby notified that any dissemination, distribution or copying of this communication is strictly prohibited. If you received this by accident, please notify the sender immediately and destroy this and all copies of it. Disclosure Required Under IRS Circular 230: Spruce Investment Advisors, LLC does not offer tax advice and any information contained in this communication, including any attachments, was not intended or written to be used, and cannot be used, for the purpose of avoiding federal taxrelated penalties or promoting, marketing or recommending to another party any transaction or matter addressed herein. 12