Global Balanced Income Class Commentary Q1 2017

Global Economic Outlook

The global economy is in a reflationary window that will likely stay open until mid 2018. Though monetary easing among developed markets is coming to an end, most central banks in emerging markets continue to cut rates. So far 13 central banks have cut their interest rates while five raised them. The unweighted average of global policy rates has now dropped below 2% an all-time low. Meanwhile, the same average for world inflation now stands at 2.5% due to the rebound in energy prices. As a result real rates have turned negative. Such accommodative conditions are no longer necessary in our view and we expect developed markets to follow the Fed’s lead and wind down their austerity programs.

Since mid-2016 we have seen acceleration in economic growth as global growth recovered from the plunge of capital spending in the energy sector and the exiting from a protected inventory destocking cycle in the U.S. While energy sector tumbled 70% between Q2 2014 and Q3 2016 (-0.79% off GDP) U.S. inventories made a negative contribution to growth for five straight quarters starting in Q2 of 2015, the longest streak since the 1950’s. The U.K. Germany and Japan experience similar inventory connections.

As we have noted financial conditions started to improve before the U.S. election and continue to do so as we write. Looking out global growth should stay reasonably firm over the next 12 months. Global economic indicators remain in a solid uptrend with recovering business spending, rise in capex intentions and strong consumer confidence. The current message from the index is that U.S. growth will remain steady for the remainder of 2017. Finally there are some storm clouds beginning to form in the distance, but for now all seems okay.

In the Portfolio

The first quarter of 2017 was one of the best in history for the U.S. markets with the S&P up 5.5% and Nasdaq up 9.8%. While many would credit Trump (he certainly will) for the move, we believe the U.S. economy was already accelerating before the election as we outlined in our Economy section. We believe we are finally normalizing the economic environment. The FOMC increased rates in March and seems more intent on raising rates. The sector now focuses on the level of rates and the Fed’s balance sheet. The U.S. is basically at full employment so the Fed has reached their target. Housing is now at levels that we experienced historically – 1.4 million starts per year. Not too hot, not too weak.

Volatility has also been reasonably in check, while consumer confidence is at new highs. Therefore unless growth deteriorates materially, rate hike expectations should trend higher, providing new term support for the U.S. dollar, short treasuries and Financial stocks.

On the fixed income side with the economic back drop continuing to improve, we continued to hold U.S. high yield double BB or better bonds. We at this time own no treasuries or foreign bonds outside the U.S. The decision to hold high yield has provided the fund a leg up on many of its competitions. It also has smoothed out some of its volatility. We also added MLP’s into the fund with a 5% weighting. With the income generated and the capital appreciation over the last 9 months it to has not only differentiated the return but has exposed us to the energy sector which we have historically stayed away from.

The asset mix continues to favour equities with a 60% equity 40% fixed exposure. We do not anticipate any change to this mix in the coming quarter.
Results for the quarter were +5.71% and this puts us in the first quarter. Looking forward returns are likely to be more muted in coming quarters as we digest for the economic and political news.

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The opinions expressed herein reflect those of the individual portfolio manager. These opinions are subject to change at any time based on market or other conditions, and Front Street Capital disclaims any responsibility to update such views. These opinions may differ from those of other portfolio managers or of Front Street Capital as a whole.

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