Beyond Mere Alpha; July 2017

Friday, July 7, 2017 - 4:07am

Risk assets continued to rally through 2Q17. This helped CB3's SMAs, as we remain 100% invested in each of our programs. I am seeing international equity markets taking a lead relative to the U.S. markets, although I am not yet ready to increase our allocation in that space. On the macro side, improving economic and earnings data in international markets are helping drive equity markets upward overseas. Attractive valuations relative to the U.S. add to the prospect of better future returns abroad. So, I am carefully monitoring this development for possible inclusion of more international assets.

In the U.S., investors started to question the path of Fed rate hikes, given weaker than expected inflation data,leading 10-year rates to fall to 2.15%. Helping CG, OV, and DI this past month & quarter was the fact that U.S.large cap equities continued their upward trajectory, up 3.1% in 2Q17 and 9.3% YTD. Of concern to me is that most of these gains were driven largely by the Information Technology sector. Small cap equities underperformed, as the strength of the domestic recovery wa called into question after a weak 1Q17 GDP print. Small caps ended 2Q17 returning 2.5% for the quarter and 5.0% YTD. Still, trailing-year returns for small cap are in excess of 30%, so we continue to look for opportunities to add those assets to the CG SMA, for those of you trading that program. Small Caps will possibly “catch-up” to the large-capitalization stock asset class when, and if, President Trump’s domestic agenda can regain the foreground headlines, rather than the news-driven spotlight sideshows that have been prevalent since the beginning of his administration.

Commodities were the sole negative return, as oil prices fell steeply amidst concerns over a supply glut stemming from persistent U.S. production. We have no Energy holdings in any of our SMAs. As I write this, Crude Oil finished the day down almost 4%. Energy prices seem destined to wallow in mire throughout the summer. Traditionally, gas prices are higher in the summer but not this year with the oil glut. Importantly, cash has returned just 0.2% YTD, meaning that investors sitting on the sidelines would have missed out on healthy returns across a wide array of asset classes thus far in 2017. And THAT is why we remain 100% invested in our SMAs.

The Manufacturing Sector remains healthy amidst the series of economic data below expectations recently, Last Monday's Institute for Supply Management (ISM) report provided strong evidence of a healthy manufacturing sector; data is a positive read-through for the near-term earnings outlook.

Balance sheet normalization from the Federal Reserve is likely coming soon. Markets will be looking closely at today's Federal Open Market Committee (FOMC) minutes for clues as to whether the Federal Reserve (Fed) will begin shrinking its $4.5 trillion balance sheet in September, and whether that means the next rate hike will be put off until December. A gradual and well-communicated path, as I expect, would reduce the odds of market disruptions.

Finally, the yield curve steepened last week for the first time in seven weeks, based on 2-year/10-year Treasuries, hawkish global central bank commentary, and the strong ISM report. A steeper yield curve has historically been a positive leading economic indicator AND it helps our bank stock holdings in CG, DI, and especially OV. Until next month, remember that CB3 Financial Group doesn’t just manage your assets, it becomes one of them!