“What a Long Strange Trip it’s Been”-Grateful Dead
Indeed, it seems like a lifetime since Donald Trump was elected President. On Friday, he will be sworn in as the 45th President of the United States. Since his election, the market has enjoyed a rally led by financials such as Goldman Sachs, JP Morgan and Bank of America. However, the rally has slowed since the beginning of the year as investors and strategists wait for concrete proposals on such important areas as tax reform and infrastructure spending. For investor’s short long dated bonds, the reflation trade of 2016 has run out of gas with the TLT up 1.83%. The best performing sectors through January 17th have been Consumer Discretionary (3.2%), Technology (3.2%), and Healthcare (2.8%). Telecommunications (-2.2%) and Energy (-1.4%) have been the laggards.
The most interesting aspect of the price action is that markets, for the first time in several years, are actively trying to pick winners and losers. Since 2009, investors have poured money into passive, index products. The U.S. stock market has been the clear winner, outperforming every other asset class. As investors attempt to predict the effects of President-elect Trump’s policies, we have seen the first meaningful breakdown in correlations between asset prices since the great financial crisis. According to Nicholas Colas at Convergex, for the 11 sectors of the S & P 500, average correlations were 62.1% last month, the second lowest readings of the decade. For perspective, sector correlations traded on a band between 70-95% from 2009 to December 2016.
Not only have we seen a drop in sector correlations, we have seen a drop in correlations in the Emerging and Developed international markets. At one point last year, both showed an 88% correlation to U.S. stocks. That number has dropped to 55% for Emerging markets and 74% for Developed markets.
For several years, diversification has meant saying you are sorry. A return to an investing world where active management is more productive is one that we look forward to. Tactical investing can offer incremental returns in portfolios that have the right sector and asset allocations. This new environment is very good news-embrace it.
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