Insights and Actions – “The new, “New Normal””

May 11, 2017

General Comments

The term “new normal” was coined to reflect the slow growth environment that has been prevalent since the end of the Great Recession.  Growth was slow for a myriad of reasons, including and not limited to, the high levels of debt in the system, weak productivity growth, very modest increases in population growth, and the changed spending patterns of a society that has aged dramatically over the past generation.

The election of Mr. Trump seemed to change that.  The prospects for the passage of a more pro-growth agenda provided hope that growth would accelerate.  Regrettably, the potential for quick legislative relief seems much less likely after recent failures and delays.

Growth in the first calendar quarter was slow yet again showing only a 0.7% improvement. The “new New Normal” is likely to be the same as the old “New Normal.”   Slow economic growth has not been rectified.  Low productivity growth has not been cured, and demographics are still destiny — we simply do not have the population growth of the post-war baby-boom era.

We have had to adjust our portfolio and sector allocations to reflect more of the same environment that has been prevalent for the past several years.

Data Points and Global Economic Indicators

Weak economic growth was reflected in lower commodity prices and in lower 10-year interest rates.  Copper prices are down nearly 10% from February highs.  Crude oil prices are down 11%, iron ore is down 28%, lumber, which had held up well until lately, has recently fallen 7%, and nickel prices have fallen 22%.  Commodity price weakness was one of the concerns we have commented on over the past several reports.

As economic growth seemed to slow, and as commodity prices reflected that weakness, we saw 10-year interest rates decline from 2.63% in mid-March to 2.39% as of this writing.

To be fair, there are plenty of economic data points that are reflecting stable, if unspectacular growth.  The recent services and non-manufacturing Purchasing Managers indices are some of those indicators, and those recent reports were above expectations, and were also stronger than the previous report.  Corporate earnings have been strong, and guidance for the coming quarters remains encouraging.  Companies remain optimistic, and executive confidence remains near recent highs.

Asset Allocation

Our targeted cash position for clients in our Tactical Equity Income and Tactical Equity Opportunities strategies is roughly unchanged from last month.  Tactical Equity Income is currently holding 15% in cash, and our Tactical Equity Opportunities model is holding 16% in cash.  Of course, the actual cash in various client accounts may differ from that number.  We have also added a small position in the developed markets.  Despite political risks in Europe, it does seem that global growth is starting to accelerate, and that is a good sign.

Sector Allocation

We have continued to reduce our exposure to the cyclical economic sectors, and have increased exposure to those areas that will continue to benefit from modest growth.  We have added to our consumer discretionary exposure, and have also added modestly to our industrial exposure.  To provide for these purchases, we have reduced our exposure to energy and basic materials stocks. Our largest exposure continues to be in the technology group where we find the potential for above-average growth.

Conclusion

The Trump reflation trade may return to prominence, especially as some of the legislative agenda promised by the new president becomes closer to reality.  It is likely that many of these items have been delayed for a few quarters, but the administration will press on.  For now, we have adjusted our holdings to reflect the environment we see.  The market seems to be taking the mixed economic news in stride, and has been successfully climbing the proverbial wall of worry.  Economic data that could be construed as either pernicious or benign seems to be taken as benign, and we share that sentiment.  This seems like a good time to pick your spots and stay mostly invested, although we admit to being somewhat cautious regarding the potential for increased political risk and/or unpredictable exogenous events.  We do acknowledge that when the facts change again, we will adjust accordingly.