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The Brave Report: Market Commentary for June 2017

View the PDF version of this report hereThe Brave Report-June 2017

Much ado about nothing. When I wrote last month’s commentary we had just seen the first market volatility in months, with the S&P500 dropping around 1.8% on May 17th.  Well, that Jolt to the system didn’t have much staying power. Within a week the index again posted all-time highs.  This has been a pattern that continues to repeat.  The market hits new highs, takes a pause or pulls back a percent or two and then the market just powers ahead, again making new highs.

With the complacency in the markets over the past few months, it seems we have been desensitized to what a real pull back looks like.  Any time an index or sector pulls back even a few percentage points the bear pundits come out of the woodwork screaming that this is the end of the bull market and that everything is overvalued.  And time after time they have been proven wrong. I know it makes for good TV to paint the picture that a 2% decrease means the world is ending but until we see a more widespread breakdown of fundamentals and a broader, deeper pullback I see no reason why the markets can’t keep setting new highs.

Now, it is important to understand that these pundits only need to be right once, and eventually they will be, but in that same vein, pullbacks of 5% or 10% or even 20% can be healthy for the markets. As long as your portfolio is allocated properly and you aren’t overly leveraged, these pullbacks can create great long-term investing opportunities.

Market Overview:

I feel like a broken record with these market updates but the market again accelerated forward over the last month.  The DOW Industrial Average was the big winner of the three major domestic indices, gaining around 3%. The S&P 500 was up around 2.5%.  The tech-heavy NASDAQ got the majority of the attention this month with a mid-month pullback of around 2.7%.  However, even with this pullback, it saw a gain of around 1.7%

On the fixed income side, we saw the 10-year bond trade in a pretty tight range, trading between a high of 2.28% and a low of 2.13%, ending near the middle by closing at 2.19% yesterday.  This tight range is quite interesting since the Fed continued its rate hikes this month. The FOMC increased the fed funds rate by .25%.  The lack of impact this had on bond rates shows that this hike was already largely priced in.I feel like a broken record with these market updates but the market again accelerated forward over the last month.  The DOW Industrial Average was the big winner of the three major domestic indices, gaining around 3%. The S&P 500 was up around 2.5%.  The tech-heavy NASDAQ got the majority of the attention this month with a mid-month pullback of around 2.7%.  However, even with this pullback, it saw a gain of around 1.7%

Profit Taking: One of the big stories of the past month was the sharp selloff in the big tech names starting on June 8th.  I attribute the selloff primarily to profit taking. On June 8th, the tech sector ETF XLK was up just shy of 20% YTD so a few percentage point drop did not change the story in the space for me.  This drop was driven mostly by the big tech names like Apple, Amazon, Facebook and Google. However, even with the pullbacks in all of these names they are still up 26%, 33%, 33% and 23%, respectively, YTD. Apple alone is up more than 50% in the last year.  With these great gains, I am not surprised that we saw some people book some of their profits heading into the summer. Locking in a 33% YTD gain before heading to the beach is never a bad thing.

As I mentioned above, we saw a number of pundits running with the story that the drops in these market driving stocks meant a more troubling trend. My argument would be that fundamentals did not change for any of these companies over the last 30 days (with maybe the exception of Amazon when it announced its purchase of Whole Foods). Panicking over a few percentage point drops in these stocks is pointless. These are all names that should be owned and not traded as I expect them to continue to shape the tech landscape and be a major driver behind the market as a whole

Political Fireworks:  Again, this month brought some political fireworks that were supposed to move markets but we never got a finale. James Comey appeared before the Senate Intelligence Committee to discuss his interactions with the President and Russia’s role in the elections. Many people were looking for a smoking gun that would set in motion the impeachment process. We saw none of this.  If anything the testimony just reiterated much of what we already knew. Obviously, each side is going to draw their own conclusions but the consensus seems to be that there really isn’t a smoking gun, yet. As the independent investigation into the matter continues to play out I think we will just continue to see sparks but no real fire. In the absence of any smoking gun that shows the president truly tried to obstruct the investigative process, I see very little happening while the Republicans control Congress. I expect the markets to continue to shrug off much of this information until something more concrete comes to light.

Interest Rates: As I mentioned above, the FOMC again decided to raise the Fed Funds Rate by 0.25% to a range of 1-1.25%.  This move was largely expected and, based on the market reaction both in the fixed income and equity space, was already priced in.  The first of two major updates from this month’s meeting were that they expect inflation to fall short of their 2% target this year.  This may be due to the delay in some of Trump’s spending initiatives that would have accelerated inflation but they seemed to paint a picture that sub 2% inflation would be the norm for at least the next 12 months.

The second major update was that they would begin the process of reducing their balance sheet that expanded greatly during the housing crisis.  To date, the committee was reinvesting all maturing debt.  They will begin to roll off a set amount each month and reinvest the rest. The goal is to build up to a point of rolling off $50 billion a month, hoping to reduce the total balance sheet to somewhere between $2 trillion and $2.5 trillion. This monetary tightening could put additional pressure on rates to the upside but this can also be read as a positive for the economy since the Fed doesn’t feel like it needs to be providing quite as much liquidity as it has been for years.  As with every other statement, the Fed continued to stress that future hikes or monetary adjustments would be data driven. So, only time will tell if this full plan gets realized.

Strategy Commentary:

I continue to maintain my equity exposure but my outlook has become a bit more cautious over the last month. Based on fundamentals, I think the market still has room to run but going into summer I would not be surprised to see another pause or slight pullback as people continue to take some profits.  I am not expecting a huge pullback but think we should be prepared in case any pullback accelerates.

I didn’t make any major changes to my portfolios over the past 30 days.  I continue to maintain my overwieghts to technology, utilities and consumer discretionary. However, I have been looking at cutting my consumer discretionary allocation to more market neutral at my next scheduled rebalance. As I have already touched upon, I still think technology still has some room to run. It’s underperformance this month hurt overall portfolio performance but it has still been my best performer YTD and I didn’t cut any exposure during the recent pullback.

I continue to maintain my international exposure as well.  Even with the run-up Europe has seen in the past few months as it has gone through some contentious elections, I think there are still some great opportunities and think the valuation picture is still attractive.  Again my bias is toward more developed international markets as I think the risk is a little more tempered in those markets but I am not staying away from emerging markets either.

I am still negative on the fixed income space. Even with the Fed rate hikes doing very little to raise overall bond rates I still think we should see rates rise over the next year. I am maintaining my underweight and am still happy to hold more cash as a replacement.  The increased cash allocation will also be helpful if there is any pullback and any buying opportunities present themselves.

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