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April 19, 2017

Thus far, US and global markets have performed well in 2017. In fact, moderate risk investors have enjoyed the best cross the board start to an investment year since 2012, with a “well diversified” 60/40 portfolio up approximately 3.2%.

But despite the respectable year-to-date performance, the mood in the market has changed as investors have grown concerned that business-friendly reforms may fall short of the expectations that ramped consumer sentiment and stocks to new highs.

In addition, economic data over the past month has been mixed.

On the positive side, surveys of consumer and business sentiment continue to show optimism at levels not seen in well over a decade, employment data has been stable, and corporate earnings have improved.

On the negative side, US economic “hard” data (not survey data) is indicating sluggish growth. In fact, it now appears that economic growth in the first quarter was likely well shy of expectations.

The Atlanta Fed issues one of the most widely followed quarterly GDP forecasts. Their latest release shows a familiar downward slope - projections have fallen from a healthy 3% in January to an anemic one-half of one percent.

GDPNow April 2017 (470x353)

Bulls and Bears

Markets in the short-term are always unpredictable, but as we assess recent market activity the delay in tax-cuts and other fiscal stimulus has definitely impacted the mood in the markets of late.

With growing concern that economic stimulus won’t be implemented quickly, some investors are reverting back to low-growth expectations and the all too familiar positioning that entails.

As bullish enthusiasm has waned, bonds have bounced back, recovering about half of their post-election losses. Also of note, the hottest sectors of the post-election rally (minus technology) have given back much of their gains.

As of today, it’s still too soon to know if this is the beginning of a trend change or simply a normal pause / rotation within an uptrend.

By year-end, the tax reform and fiscal stimulus questions will hopefully be mostly behind us, but in the near-term, the markets are likely to remain heavily dependent on stimulus news and Fed policy announcements.

Clearly, there are many in the financial media making bold calls on how these factors will play out, but bold calls in today’s investment climate are likely even a greater fool’s folly than normal.  That’s because we have the unpredictable combination of the most indecisive Fed in our financial history, and a majority political party so hamstrung in disagreement that policy uncertainty has risen to levels not seen since the 1970’s.

Asset Allocation

From strictly an investment perspective, the only significant tactical trend change we’ve seen in recent weeks is that bonds moved from a negative trend to neutral. As such, we’ve slightly altered our bond exposure, if the trend in bonds further improves we’ll extend duration, but for now, we’re mostly favoring the 3 to 10-year range.

As for stocks, the tactical models remain positive, we did trim holdings a bit in the first quarter, but that was almost entirely in the interest of not letting gains overweight equity exposure in this environment.

Moving forward, I continue to feel that investors with significant portfolios (especially those retired and soon-to-be retired) should strongly underweight buy and hold investment strategies, and overweight tactical strategies focused on risk management.

With stock valuations at levels rarely seen in market history the downside risk potential in today’s market is arguably higher than average. As such, buy and hold strategies likely represent a level of risk beyond what most moderate risk investors realize or can ultimately tolerate.

As buy and hold continues to attract the investment herd an important point for investors to keep in mind is that a strong allocation to B&H has historically been most rewarding when market valuations are low - the exact opposite scenario to our present environment.

In closing, I think the best advice for investors today is to try to temper strong opinions as to the outcome of 2017, and tactically invest in ways that provide an opportunity for upside with an emphasis on risk management.

 

*** For those not familiar with the firm, it’s important to note that we are not short-term market timers. We employ both buy and hold AND tactical / active strategies in well-diversified portfolios using transparent, inexpensive, and tax-efficient index-based ETF’s. In most environments we prefer to be balanced between buy & hold AND tactical strategies, but in high risk environments our strategy turns more tactical (active) with a greater focus on risk management. We’ve been primarily tactical since December 2015.

For more information on how and why we blend buy and hold with tactical strategies please read our Investment Strategy page.