Economics and Market Commentary
The first half of 2017 exhibited a market and economy that was continuing on its recovery. Job growth, housing, production, and consumer spending show improvement, reflecting an economy on good footing. Overseas markets appear to be even more lucrative, with demonstrated double digit year-to-date growth. Developed economies in Europe and Asia are coming out of their 10+ year hibernation.
In the bond markets, the Federal Reserve is on pace to raise the federal funds rate, as well as reduce the balance sheet. The Federal Reserve’s intent is to be gradual in this process, and bonds with interest rate sensitivity have performed reasonably well when compared to past cycles. High Yield bonds have performed particularly well as we remain on solid footing in the credit markets. In any case, a move to a more normal interest rate environment will be a welcome relief to fixed income investors globally.
Speaking broadly to the US equity markets, we have probably already seen most of the upside, and we are expecting the rally to flatten out to more sustainable returns as the market catches up to current valuations. We also feel that there are opportunities in both developed overseas markets and in select emerging economies. A number of sectors discussed below should also perform well regardless of how the broad equity markets move.
Finally, we are keeping a close watch on stressors that could possibly change the path of the equity markets. Legislation in Washington, as well as geopolitical risks may change things dramatically. We are constantly monitoring valuations and developments to prepare for any large changes that may swing the markets to the downside. We continue to adjust our model(s) and their subsequent contingency plans to manage these risks should they appear.
As we have talked about in previous communications, one of the most important components of an investor’s portfolio is tactical sector investing. At Copper River we view sector investing and subsequent sector rotation, as one of the most important tasks we can perform to improve overall portfolio performance. Almost anyone can identify the trending themes that make certain sectors attractive, as well those that make a sector less so. Here are a few of the themes that we are currently capitalizing on as we move into the fall, as well as those themes we are moving away from.
Please note that tactical investing and sector rotation using ETF’s and/or active managed funds would almost always comprise of a small percentage of one’s total market exposure. Every investors risk profile, liquidity needs and performance goals are different, and always taken into consideration before any investment is made.
Sector Rotation (In)
We feel that select emerging markets, namely India, should provide an investor with tremendous growth potential over the next few years.
As we look at this emerging market we see that the current Indian government is extremely pro-business and this is reflected in an economic growth cycle nearing 20% for 2016 and 2017. So far this year, the Indian stock market is up + 25%, but given the strong underlying fundamentals the outlook continues to look
extremely positive for long term and patient investors.
Below are a few key facts on the market as compiled by Forbes.
- India is world’s fastest growing economy.
- India is benefiting from the demographic dividend.
- India’s business–friendly government reforms have started.
- Households are increasingly saving money and investing in equities.
- India’s stock market may be undervalued when analyzed on its P/E ratio
In the early 1990’s something new came along that changed our daily lives forever. Over the last 25+ years the impact of the internet has transformed nearly every public company, private business, and consumer on a global scale.
Over the past two decades the internet has created thousands of new companies, including some of the largest companies in the world Apple (3), Amazon (12), Google (27).
The point being made here is that many experts in the market, as well as in academia, have stepped forward and predicted that the Artificial Intelligence (AI) sector will disrupt the market in ways many times greater than what the internet has done over the past 25 years.
Put at its most basic of explanations, (AI) will change the way we work in the future, communicate, travel and receive health care. It will affect every business in ways we are just starting to understand.
The attached link provides an in depth research report on (AI) from Accenture.
Sector Rotation (out/underweight)
With U.S. economic data showing improvement investors have moved into more cyclical areas of the market and away from the traditionally defensive utilities sector.
Utilities stocks have been more volatile over the past few quarters, and their performance appears to be more tied to interest rates than it has been historically. Shares have rallied when bond yields have fallen, and declined when yields have risen. Additionally, investors have been rotating out of utilities contributing to its share price underperformance this year.
Rising inflation could lead to higher rates than the market is currently expecting, potentially resulting in investors moving out of the “yield-chasing” trade that has helped to bolster the sector over the past few years.
Over the past decade yield starved investors have flocked to the REIT sector seeking an income alternative to bonds. These investors have been rewarded, with the REIT index returning nearly 400% since 2009 and outpacing the S&P500’s total return of roughly 300% over the same time period.
That said, the chart below clearly shows how REIT’s have underperformed since the Federal Reserve resumed raising interest rates. With interest rates expected to continue to increase, and continued pressure being put on retail space from internet sales this sector should continue to be challenged over next few years.
The Amazon Effect
In our next newsletter we plan on covering in detail one of the largest seismic shifts that’s been taking place in our economy over the past few years. This shift has been taking place in the retail sector, which supports 42 million jobs, provides $2 trillion in labor income and contributes $2.6 trillion annually to U.S GDP. While the internet is the main culprit for a shift to online retail sales, one company stands out for its dominance in accelerating this shift and its continued potential to massively disrupt everywhere it decides to operate.