Deltec International Group investment letter for the second quarter ended March 2017.
Dear Investor,
We are pleased to provide you with our latest Deltec Investment Letter, an excerpt from our Q2 2017 Deltec Quarterly Global Strategy Outlook presentation, entitled “Protecting Capital vs Pursuing Growth”.
Deltec International Group – Last Quarter’s Key Calls:
The below calls were published within the last Quarterly Outlook, Investment Positioning and Key Trades materials, and expressed across Deltec’s Investment Advisory, Investment Management and Investment Fund portfolios:
- Remaining Overweight Equities: Over the last quarter the MSCI All World Index generated a total return of 3.7%, more than doubling the returns of the Barclays Global Aggregate Bond Index.
- Increasing Long Technology: Over the quarter, the Eurostoxx 600 Technology Index increased by 10.4%, outperforming the Eurostoxx 600 by 5.5%, and the MSCI Japan Technology Index increased by 3.7% outperforming the MSCI Japan by 3.4%.
- Remaining Long US Housing: Over the quarter, the US Homebuilders Index increased by 7.0%, and the US Home Construction Index increased by 13.5%, outperforming the S&P 500 by 4.1% and 10.6% respectively.
- Short Commodities and Mining Equities: Over the quarter, Industrial Metals prices declined by 2.2%, Iron Ore prices declined 10.1%, and our short position in Mining Equities generated returns of 7.1%.
Protecting Capital vs Pursuing Growth:
“Where we’re going, we don’t need roads.” – Dr. Emmett Brown, Back to the Future (1985)
Our previously contrarian expectations of stronger global growth and an extension of the economic and market cycle are now being met by consensus, with higher asset prices validating our investment positioning. Following the sharp increase in global growth momentum in recent periods, a pause is expected, with regard to global growth, liquidity conditions and even asset prices. However, this pause is likely to prove temporary, as we maintain the view that, save for the parallels to the 1990s, the forthcoming periods will be like almost no other time in investing history.
From a tactical perspective, asset prices are expensive, and whilst the broader outlook remains positive, second derivatives drive investment markets, and peaking growth momentum that will decline in the coming period, coupled with changing liquidity conditions, both temporary, will likely to lead to bouts of consolidation and rising volatility. Whilst, on balance, still positive, this investing environment advocates greater capital protection, as the latest period of synchronized global growth is atypical, in addition to the multitude of changes around peaks that renders asset, country and sector allocation increasingly important.
From a strategic perspective, the global economy has entered a new regime, underscored by seismic changes that are occurring at a political, demographic and capital level. From a political perspective, more than ever, investor sentiment is being framed by the policy outlook, however ironically, recent economic and investment market outcomes have been driven almost entirely by the private sector, and are dependent on policymakers less than ever. From a demographic perspective, the focus on aging populations and protectionism masks the benefits of migration and freedom of movement in an age of labor shortages. From a capital perspective, the surfeit of liquidity of the past fifteen years is parching rapidly, with the necessary increase in capital investment to generate productivity growth already occurring, generating immense technological changes that will soon challenge the conventional notions of industrial production, inflation and asset values. This investing environment advocates the pursuit of growth, as the global economic expansion is likely to continue for several periods, and change in in terms of its participation by geography and industry, which is only partially capitalized into asset prices.
Economic and investing outcomes are rarely linear and often staccato, as is the case with the current tactical and strategic outlook. This underscores the current environment, where the deployment of capital becomes paramount to the attraction of capital, presenting substantial opportunities for active managers. This need for increased selectivity provokes misunderstanding and prompts significant risks, which manifests in investment markets as mispriced assets and tremendous investment opportunities, both long and short, and can only be negotiated through balancing the need for Protecting Capital vs Pursuing Growth.
Global:
From a strategic perspective, the relationship between economic growth, liquidity conditions and asset prices is the key long term driver of investment markets, with the outcome for any one dependent on the interplay between all. From a tactical perspective, global growth momentum (growth in the rate of growth) and liquidity growth (growth in the amount of money supply) are the key short term drivers of investment markets. The coming period will see investors challenged by the desire to protect capital in anticipation of peaking growth momentum, after a sharp increase in recent months, and stabilizing liquidity growth, after recent major changes across regions and in aggregate. Against this, investors will be beckoned by the appeal of pursuing growth, especially in a global economic expansion that is expected to continue for several periods. Read More – Global
Emerging Markets:
Emerging Markets have improved, due to the combination of increasing real interest rate differentials, stable USD liquidity conditions, improving growth momentum and significant earnings upgrades, all driving substantial capital inflows and a virtuous, albeit temporary, cycle. Globally, productivity growth is supplanting liquidity growth, structural reform is substituting competitive devaluation and trade reform is displacing globalization, benefitting in aggregate, although weighing on selected Emerging Markets. Whilst selective opportunities for significant capital growth in Emerging Markets exist at present, secular changes in USD liquidity conditions will manifest in deteriorating currencies, domestic demand and financial stability, and the periodic need for capital protection. Read More – Emerging Markets
United States:
The US outlook is framed by peaking growth momentum that is likely to temporarily decline, auguring the protection of capital, and an economic expansion that is likely to continue for several periods and broaden across sectors, inviting the pursuit of growth. Although well progressed, the economic expansion continues to broaden across sectors, with consumption, housing, industrial production all participating, and leading to increased inflation. The heralded increase in capital investment is now occurring, fostering the transition from liquidity growth to productivity growth, which will ultimately curb inflation in the outer years, underscoring an even more positive outlook. Policy uncertainty remains a risk, yet also a sideshow within a private sector driven expansion. Read More – United States
Europe:
Europe is at the crossroads of protection and growth, both from an economic perspective, as policymakers contend with their place within the bloc, and from a market perspective, as cyclical exposures benefit from an improving outlook. The overall economy continues to improve, bolstered by key trading partners, however also benefitting from increased private sector participation, despite the significant public sector risks, both fiscal and monetary. Growth momentum is strong and liquidity growth is being maintained, and, whilst both are likely to turn as the year progresses, the outright expansion is now solid enough, and the banking sector now better positioned, to withstand these cyclical changes. Demographic factors and a lack of realization of the initial goals of architects of the bloc present longer term risks to the region, hence structural reform at both a country and regional level is needed to protect the expansion, with the coming outcome of upcoming elections key to this achievement. Read More – Europe
Japan:
For the better part of three decades, the outlook for Japan has been typified by an elusive pursuit of growth. The current outlook is strongly positive, borne from the significant operating leverage to the more positive global economic cycle, still relatively low oil prices, maintained policy support and, strategically, capital investment to confound the demographic headwind. Risks remain, globally, through the exposure to China, and domestically, through issues of policy credibility. Read More – Japan
China:
China’s growth momentum is currently strong, and is likely to continue to benefit from resurgent trading partners, however monetary policy is being tightened, which will see growth slow as the year progresses. The outlook for China is characterized by the need to protect capital against the fading afterglow of the largest monetary and fiscal stimulus measures ever seen in any country ever in history, the struggle to contain capital outflows, tightening monetary conditions to curb imbalances and, the desire to pursue growth, amidst the attempt to transition the economy from investment to consumption. Moreover, the country must aim to maintain industrial production dominance sustained from labor in an age of transformative technology borne from capital, especially as elevated policy uncertainty compounds the major risks of significant capital outflows, slowing fixed asset investment growth, ongoing deleveraging and major demographic headwinds. Read More – China
Commodities:
Fervent attempts to utilize Commodities to protect capital through the cycle are futile, and the pursuit of growth at the current point in the cycle is undermined by an unprecedented deviation of prices from current and likely future demand and liquidity conditions. Slowing Chinese fixed asset investment, the primary driver of demand, changing USD liquidity conditions, a key determinant of pricing, and selectively rising supply, an irrational response mechanism, are likely to lead prices lower in the near term. Beyond this, the strategic outlook is deeply negative, as the last commodities boom is over, and the next is a generation away. Read More – Commodities
Currencies:
Relative growth and liquidity dynamics across regions, the primary drivers of currencies, are stabilizing, aiding the protection of local currency capital, however making the pursuit of growth more challenging across markets. As policymakers unwind financial crisis era policies, liquidity conditions can change rapidly, causing often unintended bouts of volatility. Peaking US growth momentum will spurn the USD, with the outlook for other currencies dependent on the outcome of factors impacting capital flows, rather than liquidity growth. Read More – Currencies
Latest Investment Positioning:
Against the backdrop of expensive asset prices, growth momentum is peaking and liquidity conditions are changing, which is likely to lead to bouts of consolidation and volatility in the coming period. This will come within a broad economic expansion that remains intact, and is likely to selectively see significantly higher asset prices as the cycle continues. Equities are expensive in absolute terms, however rising earnings should effect more attractive absolute and relative valuations. Changing liquidity conditions will positively impact Credit and Money Market Securities. Real Assets are expensive, and at risk due to deteriorating underlying drivers and liquidity. From a relative perspective, growth sensitive assets will outperform liquidity sensitive assets, with selected Equities likely to provide the most attractive risk adjusted returns, followed by Credit, Money Market Securities and Real Assets. Read More – Latest Investment Positioning
For further details, please refer to the full presentation of the Q2 2017 Deltec Quarterly Global Strategy Outlook, and the Investment Positioning and Key Trades documents. Should you wish to receive Deltec Investment Research or further information regarding investing with Deltec, please contact either myself or your Deltec Representative at any time.
Best Regards,
Atul Lele, CFA
Chief Investment Officer
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