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The Brave Report: Market Commentary for July 2017

Click here for PDF version of this report: The Brave Report-July 2017

Earnings are finally in focus. As we enter this summer’s earnings season, company fundamentals and performance finally seem to be the driving force behind the markets. Chalk it up to a slow summer news cycle but with the political gridlock, we are seeing in Washington and few surprises coming from the Fed we can finally focus on how companies are actually performing. This is great news as it removes some of the unpredictable outside pressures on the market and will hopefully give us a clearer picture of how the economy is actually performing.

During this time of year, it is easy to get lulled to sleep by the summer, figuring you will revisit your investments in September. I am not opposed to this philosophy as long as you take a few minutes to make sure your portfolio is prepared for potential large summer swings.  The last two summers have been marked by such moves. So set your long term allocations, make sure this allocation is balanced and then head to the beach knowing that your portfolio can withstand any short term volatility.

Market Overview

Over the past month, the markets again powered higher driven by the strength in technology stocks. The S&P 500 gained around 1.5% while the Dow Industrial Average grew by around 0.8%. The NASDAQ, again, was the big winner, posting gains of over 3%. This brings the YTD increase in this index to almost 19%.  We saw a slight mid-month drop in all of these indices with the NASDAQ dropping almost 2.5% but again saw all the averages work their way higher from that point to end near all time highs.

In the fixed income markets, the 10-year bond experienced a similar pattern to the equity markets. The yield moved from 2.19 percent to start the month up to almost 2.40 mid-month before coming back down to 2.27 at the close of business on July 18th. While this is more volatility than we saw last month we are still seeing rates hold within a range below where we were at the start of the year.

Earnings: Earnings season has just kicked off and I think we are finally in a place where these fundamentals will be the driving factor behind market performance for the rest of the summer.  The past three-quarters have been clouded by political uncertainty but as we have moved past the election we can start to get a better picture of how companies are performing and planning under the new administration. It is far too early to draw any conclusions but it will be important to digest not only this past quarter’s results but also what companies are projecting out into the future.  This could help us understand what tax or policy changes companies are actually taking seriously.

Earnings season will also provide us a barometer of which sectors are adapting best to any upcoming policy shifts or innovations. I think this will be most interesting in the retail space or any other areas that see Amazon as a real threat.  I normally don’t discuss individual names in these commentaries but Amazon’s impact is being felt across whole sectors as they continue to disrupt industries.  They have already completely transformed the retail sector, forcing more and more traditional retailers to either innovate or die. More recently their announcement about purchasing whole foods sent shockwaves through the grocery industry. Moving forward, companies will be forced to address this potential threat and we will start to see more and more questions from investors about what executives are doing to prepare for the Amazonization of the economy.

Politics: It is funny to me that we have been so desensitized to political news. In a month where the President’s son is tied to meetings with Russians regarding potentially politically damaging information about Hillary, North Korea continues to shake its saber and we saw another attempt at health care repeal/reform fail that we just shrug and think this is business as usual.  This new political norm has removed some day to day political risk from the markets as it seems it will take something monumental to actually move the markets. My fear in this arena still hinges on such a tail risk type of event. The market reaction to such an event could be large and swift as any pent up political tension is released. However, until that point, political news will continue to just be a sideshow to the markets.

Summer Doldrums: The summertime is always an interesting time to invest.  Some years we see quite a bit of complacency as professional investors are happy with year to date returns and are content to enjoy the summer, keeping volumes low.  However, the impact of this can sometimes be a quick market move. We saw this in 2015 as the market pulled back sharply in late August. The opposite occurred last year as we saw a sharp jump higher from mid-June thru July. The important thing to remember during these slower summer months is that complacency is normal but it is also important to make sure you are properly allocated in case of a sharp market move. So, in order to enjoy your days on the beach, make sure you make a quick check on your allocations to ensure it is not out of balance and is prepared for a move in either direction.

Strategy Commentary

I continue to maintain my overall equity exposure but have adjusted my allocations slightly over the past month. These shift

s are not an indication that I am underweight any additional areas, just a shift to some areas that have a better valuation profile and return potential moving forward.

Domestically, I rotated out of utilities and consumer discretionary and added industrials and healthcare. Even with the slight pullback in tech earlier in the month I still maintain my overweight there and think the space continues to have room to run. We have seen some swings in tech over the past two months but the fundamentals are still there to drive the space higher.  I expect upcoming earnings to confirm this.

I also decided to take some profits domestically and reallocate to some more developed international exposure, specifically Germany. I am still quite bullish domestically but with the run we have been on, taking some profits seemed appropriate.  Additionally, with political uncertainty subsiding in Europe I feel the valuation situation can’t be ignored.  I may be a little late to game in Europe, as it has outperformed over the last few months, but I still think it has some room to run. Germany continues to be the strongest of the European markets and has the lowest risk profile.  I am maintaining my allocation to emerging markets and other developed international markets as well.

I am still negative on the fixed income space. 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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