17 Mile 2.0
Strategy Note 1
June 22, 2017
Equities. Based on medium- to long-term breadth and supply/demand indicators, global and US equity markets appear to remain firmly within the cyclical bull market that began in February 2016. The cyclical bull market kicked off when global monetary policy authorities colluded to bring a halt to the strong USD-led commodity bear market; and the bull market has since been sustained by a globally-synchronized economic upturn led by Emerging Markets and Europe. It is worth noting that the US economy remained firmly in expansion mode throughout the 2015-2016 equity cyclical bear market, which, predictably, limited the ultimate downside to less than 20 percent.
Though the current US expansion that has been in place since mid-2009 appears long in the tooth relative to the post-WW2 average, the severity of the Great Recession rendered this average operationally moot by kicking off a secular deleveraging cycle that threw off the normal cyclical vagaries of the business cycle. Nobody knows when the expansion will end; but most critically for global and US equity markets is the fact that the US economy continues to expand at present, which means equity market downside is more than likely limited to no more than 20 percent in the next 12 months.
But as markets enter the historically volatile summer/fall period having avoided a 5 percent correction for a near-record amount of time, and with investor sentiment elevated and choppy, global and US equity markets are positioned for near-term weakness. Adding to the negative set-up is the fact that a record number of investors, per BAML, view global equity markets as overvalued, limiting both upside demand and downside support.
Keeping in mind the backdrop of continued economic expansion, I believe a near-maximum underweight position in equities is appropriate at this time. The Global Asset Allocation model is at roughly 90 percent of the benchmark equity weight, with room to reduce to 85 percent on further rallying; and 17 Mile 2.0 is approximately 20 percent net long with 30 percent equity cash on hand and room to reduce to 30 percent net short on any further rallying.
Sub-asset class opportunities are limited at present, with perhaps modest relative upside in Emerging Markets v. DM. Relative regional performance will be instructive in the next 5-10% market correction for where to position portfolios in the coming months and quarters.
The GAAM is very modestly OW EM at this time.
Bonds. While risky bond (non-DM sovereign) spreads are nearing historic tights, as long as the globally-synchronized economic upturn remains in place bond investors are likely safe clipping coupons for the next 6-12 months without experiencing too much volatility. But on a LT basis, risk is firmly to the downside as global monetary authorities tighten policy and inflation begins to perk up.
With “risk on” bond sectors – high yield, leveraged loans, EM – very tight, there is limited to no relative opportunity at the sub-asset class level at this time. If anything, I would be inclined to UW “risk on”, on a relative basis, on further rallying. For now, I have the GAAM at MW at the sub-asset class level and near maximum UW at the asset class level, or just over 25 percent of the benchmark weight.
US EQUITY MARKET
Strategy. The 17 Mile 2.0 event-driven, value-oriented strategy is benchmarked against the greater of the Global Benchmark (71/29 equities/bonds), the ACWI, and the Russell 3000. The R3K bench is the equity universe I manage within and the strategy must beat; the strategy must also beat the ACWI, as DM ex. US and EM are excluded from the universe; and lastly the cash management/hedging asset allocation strategy of 17 Mile 2.0 must drive outperformance against the Global Benchmark in equity bear markets.
Themes. Two major headline themes for 2017: Tech is eating the world, and the price of oil is going to $0. Only slight exaggerations.
As the WSJ recently outlined in a front page article, active managers have outperformed their benchmarks at the highest clip since 2010, due in large part to overweight positions in Tech. Not coincidentally, that same day “FAANG” stocks took an intraday plunge. Of course FAANG has since rallied back close to YTD highs – predictable, as tops are a “process” and bottoms are an “event” – but the money paraphrase of the article was: Managers are leery of Tech outperformance but are not comfortable bringing positions back to less than a market weight.
Active managers are stuffed to the gills with Tech, and for good reason: “Cheap” valuations, clean balance sheets, and growth. But while of course Tech valuations are nowhere close to the heady days of the 2000 TMT bubble, the fact of the matter is that nobody is even considering what could potentially go wrong with FAANG prices. Tech likely continues to rally for a bit; but my hunch is that the overloved AMZN is long overdue for a period of questioning Bezos’ long-term vision and strategy. Perhaps the Whole Foods purchase will inject the necessary “uncertainty”.
Of the FAANG cohort GOOG appears to be the most sustainable, as it is the most “industrial” – i.e. a toll-taker in critical central position within the global Internet economy – but global anti-trust concerns are rapidly rising. Something to watch. Outside of FAANG MSFT is very industrial-like, perhaps moreso than GOOG. AAPL on the other hand is heavily leveraged to China and elevated pricing; while there are few words for NFLX.
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Three key drivers of oil sentiment: US Shale, OPEC and autonomous vehicles.
US oil production is projected to reach 10 million BPD, OPEC produces something between 32 and 35 million BPD, and Russia around 10 million. Total global oil supply is over 90 million BPD, which means non-US/OPEC/Russia production is roughly 40 percent of total supply. These are the barrels that require a far higher price of oil, yet receive little attention. As decline rates from projects sanctioned with oil over $100 begin to kick in, US shale may no longer act as the marginal price setter.
Widespread autonomous car adoption is more than likely to take far longer than current headlines would suggest. So while LT oil demand may be capped, me thinks there will be a gap where that long adoption period meets an oil production deficit, leading to an oil spike. Who knows when and/or how long that will happen; but I believe $60+ oil will prove to be an appropriate marginal cost estimate for awhile as a result.
Miscellaneous. Staples stocks are quietly making new highs this year…IMO not solely due to lower than expected rates but in anticipation of broad market weakness. The Auto manufacturers are at an interesting intersection of the two major themes of Tech and oil – it is potentially time for a long GM/short TSLA old economy/new economy pair trade (tho the TSLA Short would be on paper…). The SoftBank Vision Fund is likely setting a NT top in Tech, but is more than likely indicative of the secular bull case for the Chip sector – much work to be done here.
The 17 Mile 2.0 portfolio is currently comprised of:
- Media: FOXA, DISCK, SNI, VIAB
- Broadcasters: NXST, SGBI
There is room to add to all positions, but more than likely on a pullback I would look to expand the portfolio at this point in time.
The 17 Mile 2.0 strategy looks to maintain a large cash position when sentiment is elevated, and a net short position when NT conditions are negative. Present conditions warrant nearly maximum defensive positioning, with any further market rallying likely capped at perhaps 3 percent.