WESPAC Advisors, LLC - Portfolio Update June 2016

June was a busy month in the news and in the markets - there was a lot to digest on many dimensions.   Donald Trump received enough delegates to become the presumptive Republican nominee on May 27th.   Hillary Clinton received enough delegates to become the presumptive Democrat nominee on June 6th.    The Federal Reserve, as a commentary in the Wall Street Journal noted, surrendered and failed to follow through with their rate normalization process and a hike in the Federal Funds Rate on June 15th.    The US Supreme Court had a 4-4 tie vote, upholding the lower court's decision to block President Obama's immigration executive orders on June 23rd.   Britain voted to leave the European Union on June 24th.     Each of these events has a material bearing on where we are headed in the economy and in the markets - we felt this warranted an expanded discussion in this month's Manager Commentary.

The emergence of a Trump versus Clinton contest in the 2016 US Presidential election pushes us into the next political phase where each candidate has a single competitor - the gloves are off, the rhetoric is increasingly sharp and personal, and the animosity is unmasked.  From an investment perspective, we have two observations.   First, this election cycle seems that it will be extraordinarily negative which could dampen investor optimism and willingness to take risk.   Second, we think this election cycle will provide an ongoing stage for already polarized electorate - we think the frequency and severity of these clashes are only going to go up.    We think the US political backdrop over the next 4 months is a concern and most likely will dampen upside opportunity in the equity markets.

The failure of the Federal Reserve to continue the rate normalization process over the past six months is a bad outcome.    The efficacy of the Fed's programs since 2010 are certainly suspect, and this failure to normalize, we fear, is creating the next bubbles that will eventually pop.    We don't think that rates are going higher in 2016, and possibly not even 2017.   The Fed's failure has prompted a reversal in rate-sensitive securities and has encourage duration risk across the fixed income markets.    Along with equity market volatility, 10-year treasury rates are under 1.5% and seem to be headed lower.    In the near term we believe this reduces the risk of moving out in duration and provides a foundation for higher yield investments in the fixed income space.    Also, we think that the Fed's lack of action likely reduces the chance of a rate shock to the equity markets for at least the second half of 2016.

The Supreme Court's tie vote concerning the legality of President Obama's attempt to implement immigration reform through executive order was seminal.    The question of how to manage immigration policies is an important short and long term question, and the Court's decision has eliminated executive order as the means for answering the question.  While there is immediate attention on the massive immigration issue in Europe, there are long-standing and festering immigration issues here in the US that need resolution.   The two Presidential candidates have starkly different views and solutions on this issue - either way, something must be done in our opinion, as it seems the system is nearly completely broken at this point.    We think that immigration issues are going to remain on the front-page for the foreseeable future and will add to investor anxiety.

The British referendum to leave the EU surprised politicians, pollsters, and to those that thought that something this anti-establishment was even possible.   Brexit speaks to a growing global trend in favor of nationalism and freedom and against unmetered globalization, immigration, regulation, and unelected bureaucracies.   Like the vast majority of Americans, we perceive Brexit as a net positive with short-term risks for Britain, the fifth largest economy in the world and the second largest economy in Europe.   We see several short-term risks from Brexit.    First, we think there is a risk that the EU is challenged by further exits which will, in turn, increase the risk of a deepening European recession and increase very specific risks to European banks that might be systemic.  Second, we think there is a risk that the US Dollar Index will resume its rally - a rising dollar will hurt US exports, resume oil's downtrend, and, in turn, re-introduce the risks of excessive debt in the energy sector.    There is, of course, one short term opportunity -- we think money flows will be net positive into the US markets, disproportionately affecting the treasury market by putting further downward pressure on interest rates.    

There are a few other observations worth noting before we discuss our overall market outlook.    The final estimate for first quarter GDP was increased to +1.1% and GDPNow for second quarter is an encouraging +2.4%.    S&P 500 earnings are expected to rise 18-20% quarter-over-quarter - if this forecast is achieved, it would mark a significant turnaround in the earnings supporting the market.   While we have valuation concerns, particularly in the defensive sectors of the US equity markets, we think the fundamental backdrop to the US equity markets is mildly positive in the short-term.

The equity markets have been in an increasingly volatile range of 1800-2130 since early 2014.    If fundamentals improve as forecast and the US continues to look like a global safe haven, there may be an opportunity for a small breakout to the upside in the markets in the short term.   However, going forward we suspect that valuations will eventually contain the market and the sideways range trade will probably continue.  These types of market conditions do provide opportunities, but they require active management strategies in order to capture those opportunities.    As always, we are vigilant in our review of daily events and will quickly become more risk averse should our assumptions prove to be wrong.

Portfolio Update

We continue to implement our plan to be fully invested, looking for positions that show both relative strength and solid fundamentals.   We continue to move towards more positions in both Core Equity and Growth and Income to guard against the growing volatility of individual positions.  

Here are some highlights of what we have been doing with the portfolios:

In Core Equity, we have been working to increase the number of positions to increase diversification.    We increased exposure to energy (WMB, OKE), consumer (AMZN), utilities (NI, AWK) and materials (MLM, NEM) while decreasing exposure to some underperforming positions (GM, CTL, GILD, SWKS, PYPL). 

In Growth and Income, we increased exposure to staples (BGS) and services (IRM) while reducing exposure to semiconductor (XLNX) and global equities (HMC).  

In Tactical ETF, we have been working to decrease the number of positions and increase allocations to favored sectors.   We reduced our position in staples from 15% to 10%, and eliminated regional banks (KRE), homebuilders (XHB) and semiconductors (XSD).