This quarter we asked Gratus Capital Director of Investments Todd Jones, MBA, CAIA to weigh in on the current financial environment and critical market trends.

Here’s what Todd is talking about this fall:

The risks surrounding North Korea seem to be severe in consequence, yet the markets are generally not responding. What are your thoughts on the geopolitical aspects of portfolio management?

The North Korea risk can be viewed similarly to other geopolitical risks we’ve witnessed or continue to experience during the past nine years of this recovery, one example being the Iran nuclear crisis. The financial markets have already accounted for such events. Market trends tend to overlook rogue states, specifically countries posing threats to world peace.

For Gratus clients, these immediate geopolitical events tend to be less important because rogue states generally have a very little operational impact on the companies we’ve invested in. Interestingly, such event risks create short-term volatility, presenting us opportunities to rebalance as well as add to portfolio positions.

Also, it’s important to recognize that parts of an investment portfolio may benefit in the event of a geopolitical situation, such as a nuclear strike. The human fear factor created by such an event can spur flight-to-safety investment activity, specifically a spike in bond activity. Ultimately, this can positively impact many fixed-income investments.

The Federal Reserve officially announced its balance sheet reduction program. How will this impact markets?

Overall, our greatest concern has been that the reduction program would be too rapid, causing financial markets to get out of hand and spiral downward. Fortunately, this is not the case. Instead, the Fed has proceeded slowly and there has been no apparent or significant adverse impact on financial markets.

For some time, Gratus has believed that the long end of the bond market, typically 10 years and longer, would be minimally impacted by the balance sheet reduction announcement. Generally, bond markets are impacted by worldwide demographics, such as people living and working longer, which typically forces bond yields down.

However, the short end of the bond market has rallied and continues to move upward. In fact, in the next two years, the yield curve may become inverted. Unfortunately, recessions tend to follow such reversed trends. Also, equities are performing well and bond yields are increasing at a measured pace.

Fixed income assets need to be carefully monitored, which is why Gratus invests in short-term bonds or similar investments with floating rates. We continue to avoid investments residing in the middle to long end of the bond market. Keep in mind that U.S. bond rates are still relatively high, and continue to be attractive to international investors.

Overall, we don’t believe the balance sheet reduction program will be the unwieldy mess that many others are predicting. In fact, equity markets are likely to grow higher. However, sensitive interest rates could create challenges for REITs, utilities and telecommunication companies.

Key Consideration

If you’ve considered refinancing in the last two years, then now is a good time to revisit this issue. We believe the balance sheet unwind will cause disappropriate pressure on mortgage-backed securities and, by extension, mortgage rates. Therefore, it’s unlikely that rates will go any lower.

Where does Gratus stand on the active versus passive investment management debate?

Gratus believes there is room for both. However, it varies by situation.

For example, inefficient markets such as U.S. large cap stocks, passive management (also known as indexation) can make sense, such as investing passively in a U.S. large cap index mutual fund given the well-established enterprises that comprise the fund. However, passive management makes far less sense when investing in inefficient financial markets, such as U.S. small cap stocks, emerging market equities and bond markets. The complexities and speed of change associated with these markets support a more active investment management approach.

How does one choose between the two approaches?

At Gratus, we believe that passive management can work for individuals in the savings accumulation phase of life. Specifically, individuals who haven’t retired. However, for those retired and in the income distribution phase of life, an active management approach makes a lot more sense. Retirees typically have unique cash flow needs. An indexation-passive approach generally doesn’t account for these special needs simply by virtue of the way passive investments are constructed.

Passive Management & Robo Advisors

Recently, Robo Advisors and their passive investment management approach have been doing well for accumulators. Therefore, if you’re seeking to be extra hands off with your investing, a Robo Advisor approach could be effective. However, keep in mind that Robo Advisors have only existed during a bull market.

Remember, a passive index fund doesn’t care about price. Instead, it just buys the index including when the index is losing value.

What are your expectations regarding the upcoming holiday season and its impact on businesses?

As far as the overall economy right now and its impact on businesses, generally speaking, the news is good. This is evidenced by a buoyant housing market, positive GDP and low unemployment rates. Also, both energy prices and inflation continue to remain low. All of these factors lead us to believe that Q4 will be a positive outcome for most businesses. However, these factors don’t always translate to upswings in equity markets.

Globally, economies are in a synchronized upswing. In fact, it’s the first time in seven years that all regions of the world are doing well when measured by manufacturing and service activities. From our perspective, the economic expansion is likely to continue through the new year.

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Gratus Capital is an SEC-registered investment advisor. Registration with the SEC does not imply any level of skill or training. Our ADV documents are available upon request.  The opinions expressed are as of October 2017 and may change as economic conditions vary. The information provided is not intended to be relied upon as specific investment advice and is not a recommendation, offer or solicitation to buy or sell any securities.  As with any investments, past performance is not a guarantee of future results. In illiquid alternative investments, returns will be reduced by investment management fees and fund expenses. There is no guarantee that any investment strategy will achieve its objectives, generate profits or avoid losses.