Beyond The Headlines

December 2016 Monthly Letter

The last few weeks following a surprise outcome of US presidential elections had a meaningful impact on the market. Half of the gains came from financials, the rest from energy, industrials, materials. The markets are hoping for looser regulatory restrictions for banks, and faster growing economy.

After nine years of record low and unchanged rates (federal fund rate of 0-0.25%), we saw the first increase in December last year (to 0.25-0.50%). A year later, this December, the Federal Reserve increased the rate by another 25 points (federal funds rate 0.50%-0.75%), and expects a 75 point increase through 2017, which is a faster pace that previously projected. The Fed is more confident in the progress the economy is making, and it is seeing strong labor market, and inflation picking up.

With rates going up, bond prices have come under pressure, and we believe it’s only the beginning. Mr. Trump’s high spend fiscal policies re-ignited fears of a potential acceleration in inflation, which support further rate increase. Thus, a long running bull market in bonds has finally come to an end.

Initially, since the money has to go somewhere, equities have been the obvious alternative to declining bonds, but caution is warranted in view of already elevated valuations, prices, and record highs.

Meanwhile, weaker growth in Japan, China, and Europe, and relatively healthy economic growth in the US have helped the dollar, where our portfolios have had the largest exposure. Rising interest rates tend to make the dollar more attractive, and since the new US president is expected to boost growth further, at least initially, further support to the dollar would not be surprising.

After a strong recovery from multi-year lows, gold has been under pressure starting last summer. This is not surprising since a stronger dollar and increasing interest rates make gold less attractive. While, for now, the investment argument in favor of gold is less compelling, we have always viewed gold as an insurance premium against unforeseen crises and the nature of insurance premiums is to cost money when things go well.

Two sectors deserve special comments: biotech and energy

Our biotech/pharmaceutics holdings had a particularly strong few weeks after Trump was elected as the next U.S. president.   The sector itself had been lackluster year to date, amid fear of government mandated price control on drugs.  While we are hopeful that the current political environment would give the sector some tailwind, our reason for keeping or reinforcing our specific biotech holdings is that we remain enthusiastic at their prospects for the next several years.

The energy sector has been undergoing exactly what we had expected, with energy price gradually shifting upwards.  Our view is that the energy sector’s turn has begun and, as a typical cyclical industry, it will have another few years of strong prospect before the market enthusiasm peaks.  Our exploration and production names have already gone up more up 50% year to date.  The service providers will follow, which is typical in this industry, as the energy price rebalance plays out in the next 1-2 years.

In a broader perspective, disciplined contrarian investors may have trouble finding compelling investments in the current environment. The majority of the stocks are close to their all-time highs, and those that are down tend to have some major issues that make them too risky to consider. With very few immediately actionable ideas, we focus on building our wish lists, and holding a higher than usual cash position as dry powder. Meanwhile, we believe that our energy and healthcare holdings leave us well positioned for the current market backdrop.

François Sicart, Allen Huang, Bogumil Baranowski

This presentation and its content are for informational and educational purposes only and should not be used as the basis for any investment decision. The information contained herein is based on publicly available sources believed to be reliable but not a representation, expressed or implied, as to its accuracy, completeness or correctness. No information available through this communication is intended or should be construed as any advice, recommendation or endorsement from us as to any legal, tax, investment or other matters, nor shall be considered a solicitation or offer to buy or sell any security, future, option or other financial instrument or to offer or provide any investment advice or service to any person in any jurisdiction. Nothing contained in this communication constitutes investment advice or offers any opinion with respect to the suitability of any security, and has no regard to the specific investment objectives, financial situation and particular needs of any specific recipient. Any reference to a specific company is for illustrative purposes and not a recommendation to buy or sell the securities of such company.