A bi-weekly publication from Consultiva Internacional, Inc. (Registered Investment Adviser) January 25, 2018
Myrna Rivera, CIMA®
As widely expected the Federal Reserve raised short-term interest rates in December to a range of 1.25% – 1.50%, the highest level for the federal funds rate since the third quarter of 2008. The highlight of the month was the completion of the 2017 Tax Reform and Jobs Act, right before Congress adjourned for the year. Another big, but not so “glitzy”, piece of news was in the municipal bond market. As details of the tax reform bill developed, some significant changes were revealed, creating a rush to the municipal bond market by issuers wanting to get ahead of a December 31 deadline, after which they would not be able to make further issuances. Despite the massive offering, there was more than enough demand for these bonds. This caused spreads to tighten further, creating positive returns for even short-maturity issues. Municipal bonds have become even more attractive in light of the current circumstances, but what does the long-term outlook look like? Government at all levels have been splurging on debt for decades with the last ten years being the worst. The economic crisis shook investor confidence and sent them looking for a government guaranty. The federal government doubled the national debt to $20 trillion in just eight years while states issued additional debt, presumably in proportion to their ability to tax property, sales and other sources of income. Should this concern investors today? Let’s remind ourselves what municipal bonds are for. Government bonds commit future revenues to current needs. When these needs lead to financing public works, infrastructure, and housing among other long-lasting assets, the net effect should be positive, as these investments should give way to economic development and additional income through tax. Bonds issued to cover budget shortfalls, pension plans, social programs and non-governmental facilities, will not have that effect and create undue pressure on future generations. This describes the current situation in Puerto Rico, where the future is now. While investors stateside might think our situation is foreign to them, Bloomberg recently reported that lawmakers in Illinois are so desperate to shore up their underfunded retirement system that they might be willing to borrow $107 billion to ride the financial markets. It would be by far the biggest debt sale in the history of the municipal market, and dwarf Puerto Rico’s debt in one fell swoop. The proposal assumes that the state can make more on its investments than it will pay in interest. A dangerous bet we all know too well on the Island.
Edmundo J. Garza
As Mark Whitehouse recently wrote for Bloomberg, the latest data on the U.S. economy suggests a good momentum, but it has still yet to lead to investments in fixed assets that would counterbalance the current rate of depreciation. Equipment deteriorates and technologies become obsolete. So it’s also important to understand whether the level of investment is enough to both offset this depreciation and expand the capital base. Growth rates alone don’t tell the whole story. In the last quarter of 2017, net private business investment was $492 billion, or 2.5 percent of GDP. That’s a big improvement from the darkest days of the last recession, when it went negative for the first time on record, but still not much more than it was at the low points of several earlier recessions. Of course, not all industry investments are equal. In the age of the internet, vast businesses such as Alphabet Inc. (Google) and Facebook Inc. can be built with less capital than used to be needed for, say, an automobile factory. That said, if companies are finding brilliant new ways to deploy capital, it should show up in productivity. So far, that hasn’t happened: During the past several years, U.S. workers’ hourly output has grown at an average annual rate of less than 1 percent, well short of the pace that prevailed in the late 1990s and early 2000s. Meager productivity gains, in turn, limit the economy’s capacity to grow. So what can the Trump administration do about this? They already have: The corporate tax cuts signed recently into law are aimed at boosting investment. In fact, this will be a primary indicator of policy effectiveness moving forward. After all, businesses should boost non-residential fixed investment in equipment, buildings and know-how to support future growth.
(As of January 25, 2018)
CPI: 2.1% Chg. from yr. ago
Source: St. Louis Fed. Res.
CPI: 1.4% Chg. from yr. ago
CPI: 0.8% Chg. from yr. ago
Source: Moody’s Analytics
CPI: 0.2% Chg. from yr. ago
Evangeline Dávila, CIMA®
Stocks: U.S. equity market returns were mixed, but generally positive in December, with outperformance shifting to value in large and mid-cap stocks, after growth dominated most of the year. Domestic equities were mostly higher for the month, as the Russell 3000 Index gained +1.0%. Large cap (+1.1%) outperformed mid cap (+0.9%) issues by a small margin, but the value-oriented indices were well ahead of their growth counterparts in both asset classes. The one outlier in the U.S. equity market was small caps. The Russell 2000 Index was down -0.4% for the month, and the growth component outperformed the value component by more than 1%. Non-U.S. equity markets continued to perform well in December, building on momentum throughout 2017. The MSCI Emerging Markets Index gained 3.6% during the month, easily outpacing the MSCI EAFE Index, which gained 1.6%.
Bonds: U.S. fixed income markets posted very modest returns in December. Yields rose 10-14 basis points in the first two years of the curve in December, tapering off to a 2-basis point (0.02%) rise on the 7-year maturity. The yield on the 10-year Treasury Note dropped by 2-basis points (0.02%) and by 9-basis points (0.09%) on the 30-year maturity. This led to the 1-3 Year Treasury Index falling 0.3% for the month, while the 20+ Year Index was up 2.6%. The Bloomberg Aggregate Index (+0.5%) was led by investment grade corporate credit (+0.8%), which outperformed both Treasury (+0.3%) and mortgage-backed securities (+0.3%). Non-U.S. fixed income markets were also positive in December, aided by the dollar’s weakness mentioned earlier and emerging markets. The Bloomberg Global Aggregate ex-USD Index was up 0.3% on an un-hedged basis and flat (0.0%) for the hedged version. Sovereign debt, measured by the Citi WGBI ex-USD Index, increased slightly by 0.1% on an un-hedged basis, while the hedged version of the Index equally dropped 0.1%. Meanwhile, the JPM EMBI Global Diversified Index posted positive returns for the both, the un-hedged and hedged versions, as it gained 0.7% and 2.0% respectively.
Alternatives: Alternative investments were mixed in December. The FTSE NAREIT Equity REIT Index declined 0.2% for the month while the Bloomberg Commodity Index was up 3.0%, as the rally in energy (crude oil was up 5.3% in December) continued through the end of the year. Hedge strategies also gained in December to end 2017 with positive returns in every month. The HFRI Fund Weighted Composite Index climbed +0.9% in December, topping the monthly performance of most equity markets. The advance brings performance to a gain of +8.5% for 2017, the best calendar year performance since 2013, and extending the record Index Value to 14,054. Inclusive of gains in late 2016, the HFRI has advanced in 21 of the trailing 22 months, including each of the last 14 months. Event-Driven (+1.1%) and Equity Hedge (+1.0%) funds led performance, driven in part by an improving M&A environment in Technology, Media, Healthcare, Retail and Manufacturing, as well as expectations for the now-enacted comprehensive U.S. tax reform.
(See the returns table below)
Sources: Callan Associates, Bloomberg, S&P-DJ, MSCI, FTSE-Russell, Citigroup, Credit Suisse, Hedge Fund Research
Ernesto Villarini Baquero
I was happy to read how start-ups going through parallel 18’s accelerator program stood up to hurricane Maria and wound up reaping rewards after. Parallel 18 is one of a very few group of business incubators and accelerators on the Island supported by local government funding, federal grants or both. This suggest some questions to citizens and investors alike: What role do start-ups have in economic development? How are they financed? And, do start-ups have a place in an investment portfolio? The Kauffman Foundation reports that because of their high-growth nature, successful start-ups account for up to 50% of new jobs created in the U.S. They also expand the commercial base by adding new business locations and encourage direct and indirect employment growth. Start-ups financing begins at the pre-seed stage, where capital is sourced mostly from FFF (Family, Friends and Fools), business angels and the accelerators themselves. Start-ups able to develop a proven product start looking for seed capital from super angels and early stage venture capital firms. Reaching the seed stage does not guarantee success. More often than not, start-ups are unable to find a profitable product-market fit and fail to meet growth expectations. The survivors pass on to series A and B financing rounds where founders usually give up a significant stake in their company in exchange for the capital needed to scale. Venture capital funds are the main source of financing at this stage, and investors will fund start-ups through these funds to gain exposure to a high-risk / high-reward asset class unmatched by the public markets. When companies reach the series C stage they are often funded by private equity firms looking to take the company public or getting acquired by a much bigger company. Here too there is an opportunity for investors to gain exposure to an asset class that is not as correlated to public markets as others, and can generate positive economic impact as well.
Typically, December is one of the best months for domestic equities, and that tendency held true this year. U.S. stocks posted solid gains in 2017 amidst a confluence of central bank and political news, as well as robust economic data. The Dow Jones Industrial Average posted a positive return (+1.9%) for the ninth straight month, the longest monthly winning streak since 1959. The S&P 500 was also positive (+1.1%) in December to cap its best annual performance since 2013. U.S. The recently signed tax reform and foreign relations should have us keeping a watchful eye out for further developments and effects in 2018. Amid an uncertain scenario we continue to recommend prudent asset allocation and risk assessment, based on future capital needs, for plan sponsors, institutions and individual investors. Due diligence reviews and an adherence to a well-developed investment policy remain the most prudent course for long-term investors. Continued fiduciary education is paramount.
Consultiva Internacional Inc. (Consultiva) is a Registered Investment Adviser. The registration with the Securities and Exchange Commission does not imply a certain level of skill or training. Consultiva has compiled the information for this report from sources Consultiva believes to be reliable. Sources include: investment manager(s); mutual fund(s); exchange traded fund(s); third party data vendors and other outside sources. Consultiva assumes no responsibility for the accuracy, reliability, completeness or timeliness of the information provided, or methodologies employed, by any information providers external to Consultiva. Conclusions reflect the judgement of Consultiva Investment Strategy Committee at this time and is subject to change without prior notice. There also can be no guarantee that using this information will lead to any particular result. Past performance results are not necessarily indicative of future performance. Diversification does not guarantee a profit or protection against loss. This document is for informational purposes only and is not intended to be an offer, solicitation, recommendation with respect to the purchase or sale of any financial investment/ security or a recommendation of the services supplied by any money management organization neither an investment advice or legal opinion. Investment advice can be provided only after the delivery of Consultiva’s Brochure and Brochure Supplement (ADV Part 2A and 2B) once a properly executed investment advisory agreement has been entered into by a client and Consultiva. This is not a solicitation to become a client of Consultiva. There are risks involved with investing including the possible loss of principal. All investments are subject to risk. Investors should make investment decisions based on their specific investment objectives, risk tolerance and financial circumstances. Global and international investments may carry additional risks that are generally not associated with U.S. investments, such as currency fluctuations, political instability, economic conditions and varying accounting standards. Annual, cumulative, and annualized total returns are calculated assuming reinvestment of dividends and income plus capital appreciation.