What now?

Brandon Snow's picture

Since the surprise Trump election last fall, we have had a few months to digest and reflect on the new world we are in.  While our first instinct was to buy any dip after the announcement, clearly most agreed with us, and the market has appreciated significantly since then.  Very quickly expectations for reduced regulations (financial, energy, etc.), rate hikes, lower taxes, and fiscal stimulus were discounted by the market.

Our expectations coming into Q1 2017 were for an end to the Trump honeymoon and the return of China-related volatility, but boy were we wrong: Q1 2017 actually ended as one of the least volatile quarters in memory, with the VIX at 11.7 (vs. 20.5 for Q1 2016).  This occurred despite the fact that the president was still having difficulty getting his agenda passed, highlighted by the collapse of discussions on health care reform.  As the market has continued to give the president the benefit of the doubt, it has posed the question: Is all this based in reality, or collectively does the market just want to believe in better growth and across the board returns?

As for China, they have continued to supply liquidity to keep their system functioning, and capital controls put in place have thus far worked to reduce outflows.  However, the trapped capital and liquidity injections seem to be keeping the property market hot (something they are separately trying to fight). So while the structural issues are still there, cyclically all looks calm today (for more details, see my recent chat here with Danesh Rohinton, our global financials analyst).

Comparing the market today to that of twelve months ago is like looking at a mirror:

  • Expectations are for rates to go up as opposed to further negatives like everyone expected a year ago.

  • Populism is a positive versus a concern, with expectations of tax cuts and fiscal spending.

  • Oil is at $50 instead of $35. 

  • People are (or want to be) bullish instead of bearish. 

  • It’s clear fundamentals have improved in a lot of areas over the last year.  Expectations have improved:

And in many ways, our funds seem to be mirror images to a year ago, the same way the markets are.  We took profits and have reduced our weights in many areas including technology, US banks, and industrials.  On the other hand, sectors including health care, consumer (mostly staples) and REITs/utilities have seen increased allocations, as sentiment has been weak and valuations have improved.

So where do we go from here?  Nobody can ever be 100% certain, for as Niels Bohr once famously said, “Prediction is very difficult…especially about the future.”  However, we can confidently make a few general statements:

1. We are in a rate hike cycle, which has previously led to credit cycles and recessions.

  • The politics of the Fed will be on display in the next year and really will determine how far they push rates.

2. Fundamentals have normalized, making improvement from here more difficult.

  • Many commodity-related areas were recessionary a year ago.  Now the pressure is off, but it remains to be seen how much economic momentum will follow through.

  • China will likely stimulate through the 19th People's Congress in the fall.

3. Investors have shown that they are now willing to take on a lot more risk than just a year ago.

  • High yield spreads have fallen by half:

  • P/Es are up by 20%:

4. More importantly for long-term investors, structural concerns remain:

  • Corporate and government balance sheets are high.

  • Misallocation of capital in China continues.

  • After eight years, we are much closer to the end of this cycle than the beginning.

Markets change, possibilities change, but our approach will always stay the same. We continue to focus on using our bottoms up analysis to find the best reward opportunities at acceptable levels of risk. At this point in the cycle, many managers continue to try to earn the returns of the past, taking on more and more risk to squeeze out additional returns. We, on the other hand, are cognizant of the risk we are taking with our investments and are willing to accept lower returns if the risks are too high.

Just know this: While patiently waiting for opportunities to come our way, we are working as hard as ever on our fundamental bottoms up research – identifying the right risk/reward price targets on the hundreds of companies we cover across sectors and around the world.  We don’t know when the next market opportunity will present itself, but our preparation will allow us to act when it comes.  For as Dwight D. Eisenhower said:

 

 

 

 

 

 

 

 

 

 

 


 

Disclaimer:

This commentary is published by CI Investments Inc. It is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein.  Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This commentary may contain forward-looking statements about the fund, its future performance, strategies or prospects, and possible future fund action. These statements reflect the portfolio managers’ current beliefs and are based on information currently available to them. Forward-looking statements are not guarantees of future performance. We caution you not to place undue reliance on these statements as a number of factors could cause actual events or results to differ materially from those expressed in any forward-looking statement, including economic, political and market changes and other developments.

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