WE Invest

November 22, 2017

Dear clients and friends,

As the market continues to defy gravity, don’t become complacent. It isn’t that we think the end is near. It really isn’t our job to predict the end. It is our job to ask why. In asking why, constantly, you feel like a skeptical teenager. But avid market listeners pick up on the underlying economic risks like the “clu-clank” sound when you start the car. The car may start, and it may run, but it also might sputter half way to Disney.

While headline news reads of a romantic novel with the occasional embarrassing tweet, there is plenty of relevant noise. For starters many policy promises that had the market ecstatic have stalled. The bond market has displayed very concerning behavior as the yield curve has flattened, the difference between short term and long-term Treasury yields, which is historically highly predictive of a recession. The high-yield bond market (below investment grade) and small-cap market has also sold off on tax policy and the effect it will have by limiting the deductibility of interest payments on companies with a lot of debt.

Equity valuations, especially US stocks, look historically expensive. Interestingly we believe the move in equity markets this year can be mostly pinned on sentiment, the way investors feel about the market. The economy has continued its fundamental recovery from the prior 8 years and investors seem to have been playing catch up, seemingly to have discounted the economy prior to the election and then priced it in. None of the big policies that can really move the economic needle have come to fruition and the market hasn’t really price them in. Now, thais is still up for debate and there are plenty of opinions on the matter. The question is, when Tax Reform finally occurs will we see the market move to new highs or is it priced in?

Given this backdrop we are not shooting for the fences, instead we are focused on avoiding the landmines. We are reducing our ETF (Index) exposure, as the approach of owning everything will be risky going forward. For example, owning a Small-Cap ETF a large portion of the stock you own are companies that haven’t ever had positive earnings. We like International, Emerging Markets best. In Emerging Markets, we are applying Environmental, Social, and Governance screening. With US Equities we are overweighing active managers and stock selection. We are underweight small-caps and have allocated more to mid-cap stocks. In fixed income, we aren’t scared. We believe fixed income is your friend, certainly ours as portfolio managers. It is important to be selective, patient, and diversified. As the economy matures and Tax policy is likely we are also adding to positively inflation sensitive fixed income.

Interestingly markets have rallied since the Presidential election in 2016 and have recently seen sell-offs and choppy markets since the one-year mark on 11/7/2017. This might be investors taking long-term gains which might continue through the end of the year. While we see multiple reasons to be concerned with market trends we believe this is an opportunity to add cash and reallocate because the combined effects of corporate earnings, tax reform, and economic fundamentals will likely drive markets higher.

As you take a break from all the news and see your loved ones this week remember we are here for you, your family and your legacy. As all of us sit down at the table for Thanksgiving we will have so much to be thankful for including our relationship with you.

Happy Thanksgiving from all of us at WealthEngage.

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