2017 Q4 Broad Market Commentary
This was an impressive year for investors. During 2017, we witnessed consistently strong returns in nearly all markets, with relatively low volatility. There was broad based growth amongst the 10 largest world economies. China and India lead the way with Q3 expansion of 6.9% and 6.3% respectively, which is not uncommon for emerging markets. The US economy was up 3.3%, followed by Japan and Canada. Economic growth continued to be realized across all sectors and regions. The stock and bond markets reflected this.
There were several drivers of this growth. Developed regions such as the US, Europe and Japan have engaged in a great deal of economic stimulus since the recession. Emerging markets are currently being led by market and trade friendly administrations.
Going forward, we do see growth continuing broadly. We expect to see flatter returns from large US companies, as the current rate of US GDP growth seems unsustainable. The Federal Reserve will need to continue to normalize rates in order to maintain its full employment/low inflation objectives (see Scott’s piece below for more on that). We do expect strong opportunities to present themselves in small cap US equities, which will benefit from the new tax laws. Additionally, we see outpaced growth in developed and emerging foreign markets, which are behind the US in their respective economic recoveries. We remain diligent in looking for any headlines, events, or changes in global conditions that could affect our clients’ portfolios.
In terms of investment sectors over the the next 12 to 18 months, our views and beliefs are as follows:
Areas we like:
-Technology – We continue to like next generation technology which will create a positive disruption in how we live our lives. We are monitoring artificial intelligence, blockchain, robotics and battery technology (that will drive electric vehicles) and believe these areas will drive growth and expansion in the global economy. (Note Bob’s commentary below for more on AI)
-US infrastructure, Aerospace/Defense, and Financials – We see these sectors benefitting from current US policy. An increase in U.S. infrastructure spending is expected to be on the administration’s agenda in 2018 and will likely receive bipartisan support.
-Oil and Gas – We feel that there are select opportunities in the oil and gas industry, which has been underperforming over the past few years.
Areas we don’t like:
-United Kingdom – We feel that Brexit issues will decrease the UK’s influence on the European Union’s economy and will reduce its competitiveness within the region.
-US Agriculture – US agriculture should remain soft as a result of increased competition from foreign markets like Brazil and Mexico.
-Retail and Related Real Estate – Retailers and holders of related commercial properties that have not learned how to effectively compete with online retailers such as Amazon and Walmart are expected to continue their struggles in the coming years.
-Crypto Currencies – This sector will have extreme volatility until the market fully shakes out and matures. There are a lot of potential byproducts of this space that keep our analytical attention, one of which is blockchain technology. We are paying very close attention to blockchain as it will have a major impact on financial services and banking.
All of these opinions are integrated into our client portfolios on a case by case basis. If you would like more insight into our views on the markets, feel free to contact us.
Bond Market Commentary and Flattening Yield Curve
As investors know by now, President Trump has nominated Jerome Powell to succeed Janet Yellen as the Chair of the Federal Reserve. Powell is currently serving as a Federal Reserve Governor, which has led the majority of market participants to believe the Fed will continue its strategy of slow and predictable tightening of monetary policy. At this month’s meeting the Fed raised rates by 0.25%, which was expected and further validates the market’s expectation of future Fed activity.
When looking at the Treasury yield curve, it is interesting that the curve continues to flatten. A flattening curve means short term interest rates have risen, while rates farther out the curve (longer term) have fallen. The spread between 2-year and 10-year Treasury yields touched 58 basis points in November and is currently holding near that spread level. By historical standards, this is a very narrow range between the 2 and 10-year Treasury bonds. For the majority of high net worth investors, the flattening yield curve should not bring immediate concern within an overall portfolio. The question is what might the flattening yield curve mean over a longer period of time?
Many economists and fixed income experts have pointed out that a flattening yield curve could imply a pending economic slowdown as well as decreased inflation expectations. Most concerning to a high net worth investor would be the continuation of this pattern to the point that the yield curve becomes inverted. An inverted yield curve happens when short term rates are higher than long term rates. While we at Copper River don’t see this happening in the immediate future, it is something we will be monitoring closely. An inversion of the yield curve has happened in all seven of the last seven recessions in the United States.
Artificial Intelligence (AI) refers to the theory and development of computer systems able to perform tasks that normally require human intelligence. Technologies can be combined in different ways to:
Sense – Computer vision and audio processing. The use of facial recognition at border control kiosks is a practical example of how AI can assist with security and improve productivity.
Comprehend – Natural language processing and inference engines can enable AI systems to analyze and understand information collected. The technology is used to power the language translation feature of search engine results (i.e. Google Translate).
Act – An AI system can take action through technologies such as expert systems and inference engines or undertake actions in the physical world. Auto-pilot features and assisted braking capabilities in cars are examples of this.
All three capabilities are underpinned by the ability to learn from experience and adapt over time.The growing use of AI is enabling computers to essentially think, learn and reason more like humans and perform increasingly more sophisticated tasks.
The Google Brain division of Alphabet employed an artificial “neural network” which improved software language translation capabilities by an order of magnitude. The new wave of artificial intelligence enhanced assistants – Apple’s Siri, Facebook’s M, Amazon’s Echo – are all creatures of machine learning, built with similar intentions (NYT Magazine: The Great AI Awakening 12/04/2016) link
How can AI drive growth?
1. Intelligent automation
2. Labor and capital augmentation
3. Innovation diffusion
The global management consulting firm, Accenture analyzed 12 developed economies and found that AI has the potential to double their annual economic growth rates by 2035 by boosting labor productivity. The rise in labor productivity will not be driven by longer hours but by innovative technologies enabling people to make more efficient use of their time.
In absolute terms, advances in AI are projected to add $15.7 trillion to global GDP by the year 2030. This is an increase of 14% over baseline projections, according to PwC, a leading international accounting and consulting firm. Of the $15.7 trillion in AI-driven global GDP increase forecasted for 2030, PwC projects that about $10.7 trillion (68% of the total) will be in North America and China combined.
The equity markets having been on a multi-year run with the DJIA advancing from 12,938 in December of 2012 to 24,746 as of December 27, 2017. Considering this historical growth, we now need to keep the concept of risk in mind for our portfolios. Risk is defined by the potential for the change in value or circumstance. Risk can be personal (relationships), physical (walking down the street, skydiving) or in this context, financial. Risk is not a bad thing, but it needs to be recognized and properly managed. Throughout the history of human advancement risk has always been present. Without risk being taken, one can not make significant advancements. Without a certain degree of risk, portfolio returns cannot materialize.Understanding the portfolio management risk concepts of beta, risk adjusted return (Sharpe Ratio), volatility, and correlation is extremely important for investors. We will discuss some of the tools that we use for risk evaluation and risk management in future newsletters.
In Closing- 2017
As 2017 comes to a close we want to thank all our HNW clients as well as the institutional clients that have entrusted us with managing their portfolios and turned to us for investment advice.
Going into 2018 we rebranded our website to better serve our client base. Please take a look when you can and let us know what you think. We wish everyone a happy new year and all the best in 2018.
With warm regards- Jim, Dave, Scott and Bob.