The New Gridlock

July 2017

There is quite a contrast these days between the volatility in the social/political world and the relative calm of the stock market.

Pick a region of the world and you will find instability:

• In the U.S. we have a President embroiled in controversy and Republicans and Democrats who can’t agree the sky is blue.
• Europe is struggling with Brexit, terrorist attacks, and a massive influx of refugees from   Africa.
• Africa is rife with drought, corruption, and mass migrations.
• The Middle East is ground zero for terrorism and sectarian violence.
• North Korea is threatening the entire southeast peninsula and the Asian region as a   whole.
• The government in the Philippines is at war with its own people.
• The President of Brazil has been charged with corruption.

I could go on.

In this midst of all this turmoil the stock and bond markets have been remarkably calm and resilient. There is a saying that the stock market climbs a wall of worry. That is certainly the case today. Measures of volatility are the lowest they have been in decades yet the stock market has continued to creep higher.

It is no secret that the market likes when we have different political parties in control of the White House and at least one chamber of Congress. This duality provides a terrific system of checks and balances and prevents one ideology from taking the country to extremes.

Right now the Republicans have control of the White House and both chambers of Congress. But not much is getting accomplished. I call this the New Gridlock.

This gridlock occurs when a single party is in control and still can’t get anything done. This happens when you have an inexperienced, outsider President that doesn’t know how to govern or build consensus. When Republicans don’t know how to listen to their constituents after spending the last eight years obstructing and forgetting how to craft effective legislation. When Democrats become the new obstructionists.

In the meantime we are stuck where we were before Trump was elected, which isn’t half bad. We have a slow growth economy with low interest rates. Not a bad environment for business. The stock market is trudging along accordingly.

For the quarter the S&P 500 was up 3% and most other stock market segments were up between 2% (small caps, utilities, real estate) and 6% (technology, healthcare, international).

Returns in the bond market were more muted. Returns ranged from -0.5% (inflation bonds) to +1.5% (intermediate bonds, high yield bonds) with most other segments falling somewhere in between.

What does the New Gridlock mean for investors?

In the absence of game changing legislation I always return to tried and true measures of valuation. The P/E ratio on the S&P 500 is about where it was a year ago (24), interest rates are still low, and the yield curve is upward sloping. All these point to a fairly valued stock market with prospects for a growing economy.

The wild cards are now, and will continue to be for some time, on the political front. For now the status quo is good. That could change depending on which, if any, measures the Republicans will be able to pass.

Tempo Financial Advisors’ 2nd Quarter Investment Performance

Tempo had a successful quarter by nearly every measure. All three strategies had positive returns and two of the three beat their benchmarks. That is five out of six for a batting average of .833. While I aim for 1.000 (six for six), I’ll take it.

The Tempo Dynamic Growth Program had a terrific quarter. Our return of +2.9% was the highest of our strategies on an absolute basis. And from a relative basis it was between 0.75% and 1% better than its benchmarks. In fact Dynamic Growth bested its benchmarks in six of the last eight quarters. Now that is a trend I like!

Many of you may have heard me talk about my goal at Tempo of tipping the risk/reward equation in our favor. Dynamic Growth in Q2 is a great example.

Tipping the risk/reward equation in our favor means either generating the same return (as a competing investment) but taking less risk, or taking the same risk and getting a higher return.

In Q2 the Tempo Dynamic Growth Program generated about the same return as the S&P 500 (+2.9% v. +3.0%), but we took less risk because we had only 60% allocated to equities. Same return, less risk! We did this by correctly allocating our equity holding to three areas that performed better than the S&P 500 (technology, financial, emerging markets).

Alternatively, a portfolio that had roughly the same risk as Dynamic Growth would also have had 60% allocated to equities. This unmanaged portfolio generated between +2% and +2.2% for the quarter. Same risk, higher return (for Tempo). Risk/reward tipped in our favor. Voilà!

Tempo Dynamic Income also had a wonderful quarter. Our return of +1.9% beat benchmarks by between 0.5% and 1.5%. Although interest rates have remained fairly low in 2017 our accounts benefitted by concentrating in areas of the bond market that are less interest rate sensitive (high yield bonds, bank loan bonds, convertible bonds).

Dynamic Income accounts have been rebalanced for the third quarter with very few changes. If the economy continues to grow at a steady rate and interest rates stay where they are (or even rise a bit) we should continue to out-perform.

Tempo Lifestyle account returns ranged from about +2% for conservative accounts to about +2.5% for more aggressive accounts. The good news is that returns were positive. The bad news is that our returns trailed benchmarks by between 0.5% and 0.75%.

Working in our favor were our overweight positions in financial, technology, and defense. Working against us were our holdings in mid cap and small cap U.S. equities as well as positions in energy (via
Master Limited Partnerships) and foreign holdings hedged for strength in the dollar. While the dollar has been strong overall the past few years, it has not been this year.

Despite the 2Q under-performance I am pleased to report that Lifestyle accounts are all up in the low to mid teens over the 12 months ending June 30 and these results are ahead of benchmarks.

You may have noticed some changes to your Lifestyle accounts recently. The net result is that I have increased our allocation to international equities at the expense of U.S. equities. The rest of the world is behind the U.S. relative to recovery from the great recession. And that means that their stock markets have not experienced as much of the up-side.

From 2009 to 2016 the S&P 500 out-performed international stocks 194% to 51%. Thus far this year international stocks have out-performed U.S. stocks 14% to 9%. This is just the beginning.


Please contact us if there has been a change in your financial circumstances that would warrant a fresh perspective on your portfolio.




Daniel J. Traub

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