Markets & Economy

Hopes and Fears and Radical Uncertainty

Hopes and Fears and Radical Uncertainty View all 2 contributors


Eight years of sluggish worldwide economic growth expectations and historically low interest rates in the developed economies finally appeared to be on their way out as 2016 drew to a close. The year began with fears of a recession and a sell-off in most risk asset classes. It ended with reaccelerating U.S. GDP growth, improving consumer and business sentiment, record highs in most major stock markets, and U.S. bond yields jumping by 70 bps in the last six weeks of the year.

Animal spirits ignited by the promise of fiscal stimulus and deregulation have sparked the hope of faster growth and consumption in the U.S. While we believe that 2017 should be a year of global economic growth, we also see an environment of emergent risks which historically expensive markets appear to be disregarding.

Equities are subject to market, market sector, market liquidity, issuer, and investment style risks to varying degrees. Bonds are subject to interest rate, credit, liquidity, call and market risks, to varying degrees. Generally, all other factors being equal, bond prices are inversely related to interest-rate changes and rate increases can cause price declines. High yield bonds involve increased credit and liquidity risk than higher rated bonds and are considered speculative in terms of the issuer’s ability to pay interest and repay principal on a timely basis. Floating rate loan securities may include irregular trading activity, wide bid/ask spreads and extended trade settlement periods. The value of any collateral, if any, securing a floating rate loan can decline, and may be insufficient to meet an issuer’s obligations in the event of non-payment of schedule interest or principal or may be difficult to readily liquidate. Although generally less sensitive to interest rate changes than fixed-rate instruments, the value of floating rate loans securities may decline if their interest rates do not rise as quickly, or as much, as general interest rates. Investing in foreign denominated and/or domiciled securities involves special risks, including changes in currency exchange rates, political, economic, and social instability, limited company information, differing auditing and legal standards, and less market liquidity.  These risks generally are greater with emerging market countries. Currencies are can decline in value relative to a local currency, or, in the case of hedged positions, the local currency will decline relative to the currency being hedged.  These risks may increase investment volatility. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. Investing in real estate securities is similar to direct investments in real estate, including falling property values due to increasing vacancies or declining rents resulting from economic, legal, political or technological developments, lack of liquidity, limited diversification and sensitivity to certain economic factors such as interest rate changes and market recessions. Alternative strategies (including hedge funds and private equity) may involve
a high degree of risk and prospective investors are advised that these strategies are suitable only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. The strategies will not be subject to the same regulatory requirements as registered investment vehicles. The strategies may be leveraged and may engage in speculative investment practices that may increase the risk of investment loss. Investors should consult their investment professional prior to making an investment decision.

An absolute return strategy is an unconstrained investment approach and performance is measured against a goal that reflects portfolio construction focused on risk management and is designed to deliver positive returns in changing market environments.  Traditional “relative return” funds are managed to and measured against broad-based benchmark indices, rather than against “absolute” measures of principal risk.

The Standard & Poor’s 500, often abbreviated as the S&P 500, or just “the S&P”, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices. The Bloomberg Barclays Global Aggregate Index is a measure of global investment grade debt from twenty-four local currency markets. The multi-currency benchmark includes treasury, government –related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.

Gross Domestic Product (GDP) is the broadest quantitative measure of a nation’s total economic activity. UMichigan Consumer Sentiment: Index of consumer confidence published by the University of Michigan on consumer attitudes and expectations in order to determine changes in consumers’ willingness to buy and to predict their subsequent discretionary expenditures. This Index is comprised of measures of attitudes toward personal finances, general business conditions, and market conditions or prices. NFIB Small Business Optimism: Index designed from a survey asking small business owners questions related to their expectations for the future and their plans to hire, build inventory, borrow, and expand. China PPI (Producer Price Index): Measure of the change in the prices received by domestic producers for their outputs either on the domestic or foreign market. USD/EUR/JPY Inflation Swap Forward 5Y5Y: Indication of the market’s 5-year inflation expectations 5-years from now. Global Economic Policy Uncertainty: Index constructed to measure policy-related economic uncertainty based on three underlying components.   One component quantifies newspaper coverage of policy-related economic uncertainty.  A second component reflects the number of federal tax code provisions set to expire in future years. The third component uses disagreement among economic forecasters as a proxy for uncertainty.  Global index is calculated as the GDP-weighted average for U.S., Canada, Brazil, Chile, U.K., Germany, Italy, Spain, France, Netherlands, Russia, India, China, South Korea, Japan, Ireland, and Australia. U.S. Labor Productivity: Nonfarm business sector output per hour worked. Labor Force Participation Rate: Percentage of the population either employed or unemployed but available and actively seeking work. U.S. Nonresidential Fixed Investment: Real private sector spending on structures, equipment, and intellectual property. Implied Policy Rate: Projected federal funds rate by the Federal Reserve used for “FOMC Dots Median”.  OIS (overnight indexed swap rate) implied forward rate used as a proxy to determine the market’s expectation of the future federal funds rate.

VIX: CBOE Volatility Index (VIX) reflects a market estimate of future volatility for the S&P 500 index based on a weighted average of the implied volatilities for a wide range of option strikes. U.S. Majors Dollar Index: Indicates the general international value of the USD by averaging the exchange rates between the USD and major world currencies. Shiller’s CAPE: Cyclically Adjusted Price-Earnings ratio (CAPE) based on the S&P 500 inflation-adjusted price divided by average earnings from the previous 10 years. U.S. Aggregate: Index used as a proxy for the performance of investment-grade bonds in the U.S.

Views expressed are those of the author(s) stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.  No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.