By David Nelson, CFA
Once again it’s that time of year when Financial firms lay out their predictions for the incoming year. I’ve played the game and while its fun putting a target on the DOW (DIA) or S&P 500 (SPY), most will prove wrong when we ring in 2018.
In the days and weeks ahead you’re going to hear bullish predictions that seem out of touch with reality to perma-bears predicting a massive correction or bear market. If you keep saying the same thing over and over again, eventually you’ll be right.
Let me put that on the back burner for the moment and focus on what professionals are really talking about.
Will it be Macro or Micro events that drive the bulk of 2017 returns?
The above is a conversation taking place at financial institutions around the world. Will it be a geo-political event or a series of them that drive markets from Risk On to Risk Off and back again? Or, will we finally get back to traditional money management focused on fundamental returns and economic outcomes?
Post the financial crisis, investor performance was largely driven by central bank policy both here and abroad. Fixed income and stocks were in strong bull markets with central bank policies around the world supporting both.
Pay no attention to the man (or woman) behind the curtain
Sure, we had the occasional geo-political setback with a terrorist attack or currency crisis causing the hiccup. But in the end, it was central bank policy that ruled the day. Post the crisis Bernanke, Yellen, Draghi and Kuroda all took turns playing the Wizard or man behind the curtain. The only thing that mattered was if central banks were accommodative and how much.
Last week’s meeting confirmed what we already knew. The Fed, after a long delay has changed course raising the Fed Funds rate for the second time in a decade. We’ll have to wait and see if the captain’s order came in time but I suspect that the long overdue process of monetary policy handing the baton to fiscal policy has begun.
Of course, the process has started but is no guarantee that fiscal proposals actually become working policy in the months and years ahead.
I’m very encouraged many of the economic proposals discussed by the incoming administration will help drive GDP. However, I’ve been in this job long enough to understand that there is a huge economic divide between rhetoric and policy. Political compromise has been with us since the dawn of the Republic and I suspect will be a driving force in the years ahead.
Inflection Point
2016 may prove to be an inflection point for markets and maybe for management styles as well. It’s pretty clear this was the year that Growth (IVW) finally gave up the thrown to Value (IVE). For the last several years investors have been crowded into a handful of stocks still exhibiting secular growth and willing to pay almost anything for the privilege. While I believe most of the FANG stocks Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Alphabet (GOOGL) will perform well, I doubt it will be to the exclusion of all others.
While much has been made of the fact that Value has trounced Growth since Election Day, the peak for this trade really took place at the end of last year.
Another changing dynamic was the rise in rates along with Financials (XLF) coming months before the election beginning just after BREXIT in June. The great rotation has likely begun with bond bears like Jeff Gundlach taking a victory lap.
Even with the obvious headwinds for fixed income there are titanic forces in place to prevent a complete collapse of U.S. bonds. On a relative basis, they may not be attractive especially against stocks with dividends close to ten year rates but when compared to international sovereign counterparts, they look like a home run.
Consumer Staples Still at Risk?
The rotation that should continue is out of Consumer Staples (XLP) with dividends only somewhat higher than the index while offering little or no organic growth. Coca Cola (KO), and many of the food companies fall into that basket. Short of potential M&A activity I find it difficult to make a case for the sector. Shorts, may have as tough time as longs with bankers focused on combining slow growth companies looking for synergies to reduce costs and increase shareholder return. (Expect more mergers in this sector)
While central bank policy may slowly be moving to the sidelines investors still have the inevitable geo-political challenges to endure. Most will prove transitory creating opportunity but some will force us to change course.
My Prediction
I’m going to approach the challenge this way. Like any pilot, I look at weather reports before stepping into the plane knowing full well that any forecast is no guarantee of clear skies. I may be forced to change course even altering my destination.
Here’s my prediction. I’m going to work as hard as I can, as long as I can to get the best investment outcome for investors. I know full well that some of these decisions will be right and some will be wrong.
There’s only one thing worse than being wrong, “It’s Staying Wrong!”
Happy Holidays everyone.
*At the time of this article funds managed by David Nelson were long $GOOGL, $FB & $SPY
