Threatening to throw cold water on the Treasury market, Fed officials in June readied plans to shrink the central bank’s sizable balance sheet. While a measured approach may not begin until September, Yellen and Co.’s lifting of the Fed Funds rate four times this cycle to 1.25% has clearly communicated the inappropriateness of a continued ultra-easy policy. European bankers are now in synch and are beginning to threaten more restrictive monetary policy. Supported by a Purchasing Managers Index that reached its highest level in six years, Francois Villeroy de Galhau, France’s central bank governor and a board member of the European Central Bank (ECB), says he now expects the ECB to start considering changes to its seemingly never ending bond-buying scheme in the fall. Higher short term interest globally and reduced central bank accommodation has flattened the yield curve both here and abroad. Importantly, the yield spread between 2-year and 10-year government securities recently went negative in China and has narrowed here from 1.35% to 0.80% for the six months ending June 22. Despite the historical tendency for yield curve flattening to forecast slower economic growth and tougher equity market conditions, U.S. and international stock indices continued to reach new highs during the quarter.

In Our Lifetime

Buoyed by this quarter’s successful passing of stress tests by the major U.S. banks, Fed Chair Janet Yellen boasted that another financial crisis was “unlikely in our lifetime.” Using stronger bank balance sheets, less leverage and greater Fed tools as supporting evidence, Ms. Yellen’s proud proclamation borders on hubris. Respectfully, after experiencing 31 years of bull and bear markets, recessions and recoveries, I wonder – does current monetary policy success guarantee future policy success or does past success demonstrate an ability to have future success? There is a big difference. Certainly I congratulate the Fed on navigating the last crisis and concur that our current credit condition is admirable. However, I find it difficult to imagine all of the economic challenges we will face over our lifetime. Just as “lower for longer” and “slower for longer” feel like a persistent optimal economic state of sub-2% inflation and full employment, will the natural forces of supply and demand never disrupt the status quo? Reminiscent of Alan Greenspan’s famous “irrational exuberance” claim, I believe Janet Yellen’s enthusiasm for our currently “well managed” banking system and economy may ultimately haunt her.


As an example of our investment philosophy and process at work, in June of 2016 our Navigator All Cap Strategy purchased Facebook for clients. At that time, we assessed that Facebook exhibited all of those characteristics which we seek when making a portfolio purchase (1) it was cheap, based on our earnings discount model, (2) it was high quality, based on our an-ti-fragility factors and (3) business momentum was accelerating, based on earnings and revenue trends. Although we usually avoid the most speculative/high momentum part of the equity markets due the richness of its component companies, Facebook in June of 2016 met all of our investing criteria. Fast forward to today — FANG stocks have sharply rallied with Facebook’s price having outpaced its growth in forecasted cash flows. While we recognize Facebook’s growth potential, it no longer meets our investing criteria and thus we have sold it. Like many voyeuristic social media users who monitor friends’ activities or portfolio managers attempting to keep up with our benchmarks, we naturally have #FOMO — or the fear of missing out. Despite this, our investment philosophy is rooted in discipline. In other words — our investment performance is derived from the continuous disciplined application of a proven investment process. As Facebook became overvalued and its business momentum began to decelerate, we have had to remove it from the portfolio and find a new company which meets our investing criteria. Certainly we are often wrong about individual investments and periodically underperform our benchmark. However discipline provides a rudder to our investment process. Without it, we would be directionless. When and if Facebook or Google or another anti-fragile, high-flying company meets our investing criteria and fits within our diversification needs, we will unemotionally add it to the most appropriate investment strategy.

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