Island Light 2016 Investment Outlook

Investment Views Q1 2016

Our investment team makes a series of investment tilts based upon our current outlook on the US and global economy, global equity and fixed income markets. Every quarter, we produce new capital market estimates that we use to manage our portfolio allocations within and between major asset categories and subclasses in order to benefit from changing conditions in global capital markets.

Q4 2015 Review: Performance, Market and Economy

2015 was not a good year for the average investor. US stocks and bonds finished the year only slightly up for the year, with a lot of volatility during the year. Global equity markets recovered from major losses in the previous quarter but finished the year slightly below zero. Slowing growth in emerging markets economies, rising US interest rates and low oil and commodity prices all impacted the global economy and outlook.

The rebound in October weakened considerably in December. The benchmark global equity index All Country MSCI ACWI increased 7.0% for the quarter and was off 2.4% for 2015.
For the fourth quarter, US markets, as measured by the S&P 500 gained 7.0%, and earned 1.4% for the year. Non-US developed markets (MSCI EAFE) recovered 4.7% in the quarter but finished the year down -0.8% while Emerging Markets were flat for the quarter (0.7%) and down significantly for the year (-14.9%). US Aggregate Bonds, reacting to the Federal Reserve rate hike in December, lost 0.6% for the quarter and returned an anemic 0.6% for the year.

Equity markets had a terrible start to the year, with the S&P 500 off 7.9%, driven by slowing growth in China, divergent monetary policies and fears of lower earnings in 2016. Non-US markets, measured in dollars were off nearly 10%. While there may be a small chance of global recession, which is the major harbinger of poor equity returns, we believe that global economies will converge to a slow 2 to 3% rate of growth. We believe that this market correction will not be sustained and remain guardedly optimistic about equity returns.

Capital Market Estimates and Views

Capital Market forecasts and estimates are critical components in the development of our portfolio allocations. When creating capital market forecasts, we employ sophisticated statistical techniques to combine observations of history with current information and forward looking views. This advanced and unique forecasting process is rigorous, transparent and practical, allowing us to include technical, quantitative factors and investment intuition to manage our investment portfolios in a consistent dynamic framework.

Portfolio Construction Methodology

We use advanced portfolio optimization technology to turn our capital market assumptions into investable portfolios. This patented asset allocation methodology, known as Michaud optimization, is designed to improve risk-adjusted returns through enhanced diversification of asset classes, selected to satisfy a range of investment objectives.

Investment Outlook – Q1 2016

We expect the US economy to continue to grow at around 2.5% with moderate confidence and US inflation over the short/mid term to remain low, with higher confidence.  We also expect earnings for the largest companies in the US to grow between 4% and 7% this year.

Overlay View – Equities

Asset Class Valuation (Global Equity Risk Premium): we expect the Equity Risk Premium to be average (6.0%) with moderate confidence
Developed Equity Timing (US vs. non-US developed market equities): we favor US developed equities with moderate confidence
Non-US Regions Timing (Europe vs. Pacific vs. Canada) we expect developed markets in Europe to outperform the Far East, Australia and Canada with moderate confidence
Emerging Equity Timing (Non-US Emerging equities vs US equities): we are negative on Emerging Markets with moderate confidence
US Equity Style Tilt (US value vs. US growth equities): we favor US growth equities with moderate confidence
US Equity Size Tilt (US large-cap vs. US small cap equities): we favor US large-cap equities with low confidence

Overlay View – Fixed Income

US Interest Rate direction (US interest rate expectation – short/mid): we expect short term interest rates to increase modestly with moderate confidence
US Bond view (US short bond forecast vs. inflation): we expect that bonds returns will equal the inflation rate with lower confidence
US Yield Curve Timing (US long bond v. US short bond): we favor shorter duration bonds with lower confidence
US Inflation-Protected Bond (US bonds vs. US inflation-protected bonds): we favor US bonds over TIPS with lower confidence
US Credit Spread (Credit Spread vs Treasuries): we see the spread increasing with lower confidence
Non-US Bond View (Hedged non-US Bond vs US Bond): we are neutral on non-US Hedged Bond with moderate confidence

Overlay View – Other Assets
Global REITs Timing (Global equities vs. Global equity REITs): we favor REITs with lower confidence
Commodities Timing (US commodities forecast): We are negative on commodities with moderate confidence
MLPs Timing (Equity MLPs vs US equities): we are negative on MLPs with low confidence
Global Macro Timing (Global Macro expectation): We are neutral with moderate confidence

“Confidence” is the strength of our forecast rating from Low to High.

Island Light is pleased to share our capital market forecasts with professional investors who ask for them. Please drop a line or give us a call for our capital market forecasts for the upcoming quarter and year. Our capital market assumptions are forecasts and reflect our forward looking views as of January 18, 2016. Such views do not express or imply a guarantee or warranty of any kind, but are estimates of future market returns. All views expressed above are the views of Island Light Capital.


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