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Trademark Market Perspective for May 3rd, 2017

I just returned from the Morningstar conference in Chicago.  I always find it interesting to compare each conference I attend to past conferences in order to determine what issues become more and less important over time.   The active-passive debate generated a lot of discussion.  Morningstar derives an important part of its income from rating mutual funds and would therefore likely be hurt by the demise of active funds, yet it threw out only modest support to the active fund industry (specifically Dodge & Cox and PRIMECAP Odyssey).  Ironically, greater support for active funds came from Blackrock, the owner of iShares, CEO Larry Fink.  Also, while it is no secret that growth as a strategy has run laps around value since the last recession, growth managers seemed to take index performance criticism more personally.  Value managers across the board acknowledged their struggles in this market but felt certain that their time would come. There were two other areas that were prominent at the conference this time that were hardly even issues in the past, behavioral finance and sustainable investing.  When I began my investment career, Modern Portfolio Theory ruled the land.  Nobody dared say out loud that investors weren’t rational.  If two investors ever came to opposite conclusions, it had to be that their time horizons or investment mandates were different.  Or one had information that the other didn’t.   Today the industry seems to fully embrace the notion that investors (even professionals) have biases, and emphasis is now on how to recognize and use them. Sustainable (or ESG) investing has flourished recently as it has emerged as a more palatable way of avoiding “bad” companies.  The goal of ESG investing is to invest in companies whose practices rank high in environmental, social and governance performance standards.  The environmental screen helps avoid companies (such as those in the coal industry) whose assets might become stranded as more climate-friendly power generation grows in usage.  Social seeks to avoid companies whose policies might generate unfavorable publicity and/or lawsuits, such as discriminatory hiring or anti-consumer practices (among other things).  Governance issues sought to expose the fact that in companies where employee relations were poor, minority shareholders were ignored, or executive compensation was excessive the stock tended to underperform.   Morningstar paid only the mildest attention to what it called “socially conscious” investing in the past, but is fully on board with sustainable investing today. Nobody at the conference disagreed with the notion that stocks and bonds are both fully valued (if not expensive), but very few thought that the current environment (2% growth give-or-take and an inflation rate of under 2%) posed any threat to the bull market’s continuance.  The biggest risk factors cited were rising U.S. rates and a strong dollar.  Mildly disappointing GDP or retail sales are not going to kill the bull market. Investing ideas:

  1. Last winter in the wake of the market reacting to what it though President Trump would do, interest rates rose sharply. The 10-year Treasury bond briefly exceeded 2.6%.   Speculative trading positions were very short the 10-year as many projected 3% yields by June.  Fast forward to today and traders have closed those positions at a loss.  Trading sentiment among speculators is now that interest rates will go lower.   I think that sets us up for a test of 2.50% at the very least.  Now may be a good time to trim duration.

  2. Another area I believe investors will prioritize is dividend growth. For a long time, investors preferred companies with excess free cash flow to buy back stock as opposed to paying big dividends because dividends are taxable.  Today there is a growing sense that stocks are so expensive that share buybacks in most cases don’t make sense.  For this reason, companies are increasingly opting to declare one-time special dividends (most recently Costco), and investors are rewarding that choice.

  3. This is the part of the market cycle where it is the most difficult to hold value stocks. One value manager said that he understands that he is “asking people to own names that they will probably hate”.  Some people are better off acknowledging that they don’t have the stomach to be value investors and not investing that way in the first place, he said.  That avoids “bad exit under-performance”.

  4. Dollar-based emerging market investors have been the biggest beneficiary of the fact that the dollar has been unexpectedly weak this year. A strong dollar forces countries that borrow in dollars to use up more local currency to pay bondholders, negatively impacting liquidity.  This is something EM investors have to watch carefully.  For the moment, however, the dollar decline is a positive for EM, and off-the-cuff tweets only make this situation better.  The risk factor here is a comprehensive tax reform package that would incentivize companies to repatriate overseas capital. Past performance is no assurance of future results. Trademark Financial Management, LLC (“Trademark”) is a registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with registration requirements imposed upon investment advisers by those states in which Trademark operates. Trademark may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. A complete list of all recommendations will be provided if requested for the preceding period of not less than one year.   It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list.  Opinions expressed are those of Trademark Financial Management and are subject to change, not guaranteed and should not be considered recommendations to buy or sell any security. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein or by calling 952-358-3395. Please read the disclosure statement carefully before you invest or send money. Any reference to a chart, graph, formula, or software as a source of analysis used by Trademark Financial Management staff is one of many factors used to make investment decisions for your portfolio.  No one graph, chart, formula, or software can in and of itself be used to determine which securities to buy or sell, when to buy or sell them, or assist any person in making decisions as to which securities to buy or sell or when to buy or sell them.  Any chart, graph, formula, or software used is limited by the data entered and the created parameters. The data was obtained from third parties deemed by the adviser to be reliable. Nonetheless, the adviser has not verified the results and cannot be assured of their accuracy. I personally believe value managers need an economic growth expectation of less than 0.5% or greater than 3% to regain favor versus growth.  A slowdown to less than 0.5% signals recession and would likely compress growth P/E multiples.  An acceleration to 3% or more signals the kind of strong expansion that encourages capital spending and makes cyclical stocks the biggest winners.  I believe neither is in the cards in 2017. Environment, Social, and Governance

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