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PGAM 4Q16 Investor Letter

The surprise election of Donald Trump as President of the United States shaped global equity markets for the fourth quarter. In the hours immediately following the declaration of Trump as the winner of the November 8 Presidential election, the U.S. stock market sold off sharply.  However, the market regained its footing in the wake of the Clinton concession and the Trump call for unity.  A rally commenced in the U.S. stock market which continued through the end of the year.  A more favorable assessment of prospects for the U.S. economy also led to a strong U.S. dollar, which had a negative impact on returns in non-U.S. equity markets for dollar based investors.

Since the election, the U.S. stock market has focused on the prospective changes in government policy viewed as pro-growth. These include a large program of infrastructure spending, less regulation of the U.S. economy, lower individual tax rates, and corporate tax reform which includes a reduction in corporate tax rates, the expensing of capital investment, and incentives for repatriation of overseas funds.  Anecdotal evidence outside of higher U.S. equity prices is already appearing. On December 22, the CEO of Bank of America, Brian Moynihan said mid-sized companies “are friskier, they’re more active”.  The report on consumer confidence from the Conference Board, released on December 27, showed this measure at its highest level in 15 years would have a positive impact on the U.S. economy.

We agree that these changes have a good probability of coming to fruition and that they would contribute to faster growth in the U.S. economy.  The main uncertainty is in the timing where disappointment could lead to market volatility.  At the same time, investors seem to be ignoring other aspects of a prospective Trump economic program which have a lower probability of happening, but could have a negative impact of the U.S. economy.  One example would be the imposition of tariffs on imports, with levels of 5-10% being discussed. Such measures would lead to higher prices across the board for U.S. consumers while an accompanying further strength in the U.S. dollar and prospective retaliation by other governments could severely crimp U.S. exports.  Similarly, the imposition of deportations of undocumented immigrants could disrupt the U.S. economy by causing labor shortages in key areas such as agriculture.

Uncertainty is also created by the apparent propensity of the new President to single out individual companies for criticism, as exemplified by tweets concerning Carrier, Boeing, and General Motors.  Although the medium of communication is vastly different, there is precedent for such an approach in 1962, when President Kennedy singled out U.S. Steel for raising steel prices, which forced the company to back down. These uncertainties have the potential to create increased volatility in equity prices.

Outside the U.S., Europe faces a series of elections in 2017 which create uncertainty.  These include French Presidential elections in May and German parliamentary elections in late September. In addition, the U.K. is likely to declare Article 50 to be in effect by the end of March, which would begin the process for Britain to negotiate its departure from the European Union.  These developments seem to be reflective of populism in Europe which is likely to pressure governments to depart from the austerity in fiscal policy that has prevailed for several years. Japan is also undertaking aggressive action to escape from its multi-decade stagnation. The weakness in the yen which has developed in recent months should assist in this endeavor.  China is continuing to pursue policies which shift the economy toward domestic consumption.  All-in-all, global economic growth seems likely to gradually accelerate in 2017, led by the U.S.

As active managers, we have the flexibility to take advantage of the stock market volatility which will inevitably accompany the economic uncertainties.

Our current equity strategy is to remain overweight in sectors that are beneficiaries of faster economic growth and an accompanying acceleration of inflation and rise in global interest rates.  We also favor sectors that benefit from corporate tax reform and less stringent regulation, including:

  • Financials: Favor companies that have earnings tailwinds from higher interest rates, lower tax rates, and increased trading revenue due to market volatility.  Leaner cost structures due to years of cost reductions and easing regulations support further earnings upside.
  • Energy: Constructive for a recovery in oil prices due to coordinated OPEC supply cuts and steady oil demand growth.  After years of restraint, North American producers are well positioned to meet a supply shortfall.
  • Technology: Focused on multi-national companies with large positions of offshore “trapped” cash that can be repatriated at favorable rates for cash returns to shareholders, investments in research and development and acquisitions.
  • Health Care: Attractive valuations following the sector’s “pause” in 2016 due to drug price reform risk and a lack of new drug approvals.  Severe reforms are now unlikely and many pharmaceutical and biotech companies benefit from cash repatriation.
    We will communicate any changes in strategy on a timely basis.

Fixed Income:
The perception that economic growth is accelerating and an accompanying increase of inflationary expectations led to an across-the-board rise in interest rates climaxed by a Federal Reserve Open Market Committee increase in short term interest rates in December.  Yields on two year Treasuries rose from 0.8% to 1.2% during the fourth quarter while the yield on ten year Treasuries increased from 1.6% to 2.5%. This yield increase in the ten-year Treasury represented an 8% drop in value for the quarter as compared with a decrease of 0.8% in the value of the two year Treasury over the same time period. The yields on German and Japanese bonds rose into positive territory of 0.2% on ten year German bonds and 0.1% on ten year Japanese bonds by the end of the fourth quarter of 2016.

Our current expectation is for interest rates to continue in an uptrend during 2017, led by further increases in short term rates by the FOMC.  The extent of these increases will depend on the pace of U.S. economic growth, further tightening of the U.S. labor market and evidence of acceleration of inflation.  With this outlook in mind we are adhering to our strategy of maintaining shorter than average maturities in our taxable and tax exempt fixed income portfolios.  In taxable portfolios our focus in new purchases is on corporates which present attractive reward/risk characteristics.


Princeton Global Asset Management LLC

Important Disclosures:
This report is for informational purposes only, and contains data based on information Princeton Global Asset Management (PGAM) believed to be accurate.  However, PGAM cannot assure the accuracy of the data. Past performance is not a guarantee of future results.  Portfolio holdings and characteristics are subject to change. The information in this report should not be considered a recommendation to purchase or sell any particular security. It should not be assumed that any of these securities transactions or holdings that may be cited were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of securities cited.

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