weekly market review - CLS Investments

WEEKLY MARKET REVIEW AUGUST 16, 2016

Market Performance

In This Edition • What does hosting the Olympics mean for the country’s economy?

Stock Market

LAST WEEK

QTD

YTD ‘16

+0.11%

+4.57%

+8.36%

Domestic Large-Cap Equity2

+0.12%

+4.32%

+8.32%

Domestic Small-Cap Equity3

-0.08%

+6.89%

+9.26%

+2.82%

+7.18%

+6.08%

Developed International Equity

+2.85%

+6.60%

+1.88%

Emerging Market Equity

+2.80%

+9.52%

+16.54%

LAST WEEK

QTD

YTD ‘16

+0.42%

+0.53%

+5.87%

0.00%

+0.03%

+0.14%

Total U.S. Market1

• Do bonds still belong in portfolios?

International Equity4 5

• What are alternative investments and why are they important?

6

Fixed Income U.S. Bonds

7

Cash Equivalent

8

Russell 3000 Index 2S&P 500 Index 3Russell 2000 Index 4MSCI ACWI ex-U.S. Index 5MSCI EAFE Index 6MSCI Emerging Markets Index 7Barclays Capital U.S. Aggregate Bond Index 8Barclays Capital 1-3 Month U.S. Treasury Bill Index 1

Week in Review The overall market (Russell 3000) had a small gain last week with large-caps (S&P 500) up slightly and small-caps (Russell 2000) down slightly. International stocks meanwhile, had a great week, gaining nearly 3%. Developed markets (MSCI EAFE Index), such as Europe and Japan, gained 3%, as did emerging market stocks (MSCI Emerging Markets). The bond market also gained ground last week, with the 10-year Treasury ending last week with a yield of 1.54%. Commodities were up over 2% last week. In this week’s commentary, three members of CLS’s Portfolio Management Team provide commentary within their areas of interest and expertise.

Olympics and Markets

The Olympics may seem like a boon for the host country. But putting on a spectacle of massive proportions, especially for a less-developed nation, can be daunting. About six years ago, I was in Mexico City on a business trip. In the cab ride from the airport to the hotel, we hit a huge pothole that almost broke the car down. I noticed many of these potholes and asked the driver about them. He informed me that insurance does not cover pothole accidents, but residents can submit a complaint to the local government authority and should get reimbursed within a few months. There is quite a backlog, he added, so it could take up to a year. “That doesn’t seem very cost efficient, why not just fix the roads?” I asked. “Well, the government is very heavily in debt from hosting the Olympic Games,” the driver answered. The Olympics were hosted in Mexico City in 1968. More than 40 years earlier! The main issue is that a lessdeveloped country typically does not have the infrastructure to host such a huge event, so it has to build everything from scratch: stadiums, hotels, even roads. And all of this has to be done in a short period of time. So, while it may bring tourists and national pride, the Olympics are probably a net negative.

How Do the Olympics Affect the Host Country’s Local Market? If we evaluate the market performance from start to finish (two weeks) of the last eight summer games, the local index of the host country increased in value six times (75%). The catch is that the average percentage gain of 1.8% was pretty much in line with the broad MSCI World Index. The brighter side is that over the year following the Olympics, six out of eight countries beat the index with a percentage gain of more than double (23.8% versus 10.7%). Will This Bode Well for Brazil? Unlike the controversial issues surrounding the Rio Olympics (contaminated water, rising crime, and the prevalent Zika virus), there are a few tailwinds that have boosted performance and contributed to a hike in returns of almost 70% this year! About half of that return comes from the strengthening currency (weakening U.S. dollar). Another portion is a result of improving commodity prices. In addition,

rising hopes for the impeachment of President Dilma Rousseff for hiding budget deficits through illegal accounting maneuvers has some investors feeling more confident about Brazil’s future. Can this momentum persist? It becomes less likely as market valuations creep up. Where Else Can You Look for Performance? Sponsors have historically done pretty well during and after the Olympics. The chart below shows the average returns for four major sponsors since the 2000 Sydney games. The chart tracks their performance during the Olympics (green) and one year after (blue) versus the MSCI World Index. Coke stands out as an underperformer for the ‘year after’ period. Perhaps it is because people are drinking less soda and more bottled water (bottled water is on track to outsell soda this year). Hopefully this gives you some things to think about as you tune into your favorite sports!

Relative Performance of Worldwide Olympic Partners vs MSCI World Index Percentage Points above/below MSCI World Index

By Kostya Etus, Portfolio Manager

8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% (1.0%)

Samsung Electronics Co., Ltd.

McDonald’s Corp.

Panasonic Corp.

Coca-Cola Company

(2.0%) (3.0%) (4.0%) (5.0%) Avg % Change from Start to End of Olympics vs MSCI World Index 1-Yr Avg % Change After Olympics vs MSCI World Index

Source: FactSet

Bonds Continue to Earn a Place in Portfolios By Josh Jenkins, CFA, Portfolio Manager Investors have been fearful of rising rates since the Federal Reserve (Fed) indicated it would begin to taper its quantitative easing program in the spring of 2013. In what became known as the “Taper Tantrum,” bond yields increased sharply as a future of much higher rates was priced in. During this period, many investors wanted to dump their fixed income allocations completely. Ultimately, the fears in the bond market proved to be unfounded, and the bull market in bonds remained intact. Since the “Taper Tantrum,” the Barclays Aggregate Index, a proxy for the domestic bond market, has returned more than 3% per

annum. This performance has been far superior to the doomsday predictions from many investors and market pundits. 2016 has offered yet another great example of why investors should stay balanced in their asset allocations. The year started off with substantial volatility, and by mid-February the global stock market had fallen by more than 10%. The bond market, however, had a positive return of more than 2% during this time. Eventually the global equity market recovered, and by last Friday’s close it produced nearly a 7.0% return. Environments like this remind us that an appropriate allocation to bonds can give investors the strength and confidence to stay invested. Investors who are

unbalanced may be more likely to make emotional decisions, such as selling at a market bottom, which ultimately hurt them in the long run. Despite the recovery in equity markets, the bond market continues to have a stellar year. CLS portfolios have certainly participated in the upside. One of our investment themes for 2016, Creative Diversification focuses on actively managing our fixed income exposure and has added a lot of value to portfolios. Two areas we have emphasized are high-yield and emerging market debt, each of which has handily outperformed stocks so far this year.

Diversifying Returns: Why You Need Alternatives By Mark Matthews, Junior Investment Research Analyst What are Investments?

•

Managed futures is a dynamic beta strategy that seeks positive returns by capturing price trends across major asset classes. This momentum-based strategy is designed to participate in the upside of the global stock index, interest rate, currency, energy, and commodity futures markets. In addition to participating in the upside, this strategy has the ability to short the aforementioned markets, which serves as significant downside protection in market drawbacks. Managers of these products follow disciplined, sophisticated modeling approaches to identify persistent trends and avoid emotional reactions to market events.

Alternative

The term “alternative investment” can be rather fluid in its meaning. Perhaps the most important and applicable definition is a nontraditional and risk-diversifying asset. Three asset classes that most aptly fall into these categories include private equity, hedge fund replication strategies, and managed futures.

•

Private equity provides the potential for exponential return outside the confines of the public market. Longterm in nature, private equity returns provide implicit liquidity premiums for investors. Hedge fund replication strategies provide access to complex investment methodologies that exploit disconnections and inconsistencies within the marketplace. The use of leverage, long/short equity strategies, and derivatives in domestic and international markets provide substantial flexibility in achieving desired outcomes regardless of the market environment. Employing these strategies allows managers to allocate across a broad spectrum of absolute-return-oriented strategies, cancel out market swings, and better manage market risk.

These investing options have traditionally been reserved for institutional and high net worth (qualified or accredited) investors as a result of their illiquidity, lack of transparency, and lack

Benefits/Risks Investments

of

Alternative

As with all investing, allocating to alternative investments is not without risk. The most critical is the possibility that alternatives may disappoint in strong up markets, but the primary function of allocating to alternative investments is to protect the downside. Other risks include complexity and higher fees. Despite these factors, the benefits associated with these investments warrant the added risk. Alternative investments can reduce risk significantly as a result of low to zero correlation to traditional stock and bond

Markowitz Efficient Frontier Expected Return

•

of availability. High correlations among traditional asset classes during the financial crisis, however, brought about a new found popularity among retail investors. As a result, product innovation has increased rapidly, making these assets accessible to a broader universe of investors.

Traditional and Alternative Investments

Traditional Investments Only

Source: Baird Private Wealth Management

Expected Risk

Diversifying Returns: Why You Need Alternatives investments. In addition, the enhanced returns, due to the wider investment opportunity set, allow for the potential to achieve similar or higher returns at reduced volatility levels (see graph on prior page). CLS’s Use Investments

of

Alternative

CLS not only uses alternative investments in our more

aggressive strategies to manage risk levels and enhance the overall return profile, but also offers an all-alternatives strategy. Our Focused Alternatives Strategy was launched in September 2013 and takes advantage of all available methodologies within this space. With its performance driven primarily by the recent success of its private equity allocations, Focused Alternatives is outperforming its benchmark

so far this year. With the current environment of low interest rates, global uncertainty, and increased correlations between bond and equity markets, we see this strategy as an ideal way to navigate volatility, access diversified returns, and improve the investor experience through positive, risk-adjusted returns.

Kostya Etus Portfolio Manager Konstantin “Kostya” Etus began his career at CLS in 2011 as a Trading Specialist and became Research/ Portfolio Analyst in early 2013. Later, he was promoted to Associate Portfolio Manager. Mr. Etus is currently a co-manager on two mutual funds and lead manager on various separate account strategies. Prior to working at CLS, Mr. Etus worked as an Associate Financial Analyst at ConAgra Foods, Inc., managing the company’s global cash network. He graduated from the University of Nebraska with a Bachelor of Science in Business Administration, obtained Master’s degrees in Investment Management and Financial Analysis, as well as Business Administration from Creighton University, and holds the Series 65 securities registration.

Josh Jenkins, CFA Portfolio Manager Joshua Jenkins joined CLS in March 2013, and serves as a Portfolio Manager. He is the lead manager of an income-focused separately-managed account strategy and also functions as the lead analyst for the CLS Growth and Income Fund, CLS Flexible Income Fund, and the Milestone Treasury Obligations Fund. In these roles, Mr. Jenkins utilizes fundamental and technical analysis to assist portfolio managers in asset allocation decisions. In addition, due to his extensive knowledge of Exchange Traded Products, he drives CLS’s implementation process and is integral in selecting the appropriate ETPs to gain desired exposure within CLS portfolios.

Mark Matthews Junior Investment Research Analyst Mark Matthews joined CLS in 2015 as Junior Analyst. Before joining CLS, Mr. Matthews worked as a controller for engineering firm, Dennis Corporation. He also held previous roles at TD Ameritrade in the Risk Management Division, where he was responsible for creating and updating quantitative risk models used to identify volatile securities, as well as implementing parameters to mitigate associated risk. Mr. Matthews graduated Magna Cum Laude from Benedict College in Columbia, SC. He also holds a Series 65 security license, a Master’s degree in Security Analysis and Portfolio Management, as well as Business Administration from the Heider College of Business at Creighton University.

The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market. The index is composed of the 3,000 largest U.S. stocks. The S&P 500 Index is an unmanaged composite of 500-large capitalization companies. This index is widely used by professional investors as a performance benchmark for large-cap stocks. The Russell 2000 Index is an index comprised of the 2,000 smallest companies on the Russell 3000. It serves as a benchmark for small-cap stocks in the U.S. The MSCI All-Countries World Index, excluding U.S. (MSCI ACWI ex US) is an index considered representative of stock markets of developed and emerging markets, excluding those of the U.S. The MSCI EAFE Index is a composite index which tracks performance of international equity securities in 21 developed countries in Europe, Australia, Asia, and the Far East. The MSCI Emerging Markets (or EM) Index is a composite index which tracks performance of large and mid-cap firms across 21 countries classified as emerging market countries. The Barclay’s Capital U.S. Aggregate Bond Index measures the performance of the total United States investment-grade bond market. The Barclay’s Capital 1-3 Month U.S. Treasury Bill Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general. You cannot invest directly in an index. The views expressed herein are exclusively those of CLS Investments, LLC (CLS), and are not meant as investment advice and are subject to change. CLS is not affiliated with any companies listed above. No part of this report may be reproduced in any manner without the express written permission of CLS. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument. CLS is not making any comment as to the suitability of any funds mentioned, or any investment product for use in any portfolio. There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not a guide to future performance. Individual client accounts may vary. Investing in any security involves certain non-diversifiable risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies. The graphs and charts contained in this work are for informational purposes only. No graph or chart should be regarded as a guide to investing.

2284-CLS-8/15/2016