December 20, 2016

We had a good start to the quarter as equity markets declined in October.  Stock selection within Staples and Technology were big contributors as investors continued to deal with high valuations, a volatile political environment, mixed economic data, and an uncertain earnings outlook.  Amidst a backdrop of slow and uneven global growth and corporate profits, the portfolio has been positioned mostly in secular growth stocks.  As a result, it has been a much more difficult environment for the portfolio since the election.  With regard to QTD attribution, our underperformance has come primarily from being underweight smaller cap and more cyclical areas of the market and overweight sustainable growers.  The market has rotated quickly towards an even more cyclical posture as investors are now discounting a bigger acceleration in economic growth, inflation and profits as we move towards fiscal stimulus.  This rotation seems to have come tactically in the form of ETFs and index funds.  Given the downward pressure on some of the sustainable growth companies in the portfolio, we believe our style has been a funding source for this trade.  This is also evident when looking at returns since the election of various style benchmarks such as the Russell 1000 Growth  (low single digit gain) and Russell 2000 Value (high teens percentage gain).   While we are hopeful that President Elect Trump’s agenda of tax reform, less regulation and more infrastructure spending could improve growth, there are reasons to believe the timing and magnitude investors now seem to be discounting might be too optimistic.   Already sizable fiscal deficits, large amounts of existing debt, combined with weak demographic and productivity trends likely mean structurally slower growth going forward (moderate at best).  Additionally, potential fiscal stimulus is coming very late in this economic cycle and, as a result, may not be as effective as we have already satisfied much of the pent-up demand since the end of the Great Recession.  We expect rates to continue to rise and the dollar to strengthen, both of which serve to tighten monetary conditions, dent corporate profits and potentially offset the benefits of government spending.  To sum up, the market is now discounting most of the potential benefits of the new administration’s policy agenda while overlooking potential offsets with respect to timing and impact.

While we think these policies could be significant in the long run, we also think investors will be disappointed in the short run.  The market will probably remain range bound and elevated into year end and possibly until the inauguration.  Favorable seasonal trends, low risk of recession and accommodative central bank policies are supportive of share prices.  We do think volatility will pick up once the new administration is in place and the task of moving their agenda forward gets underway.