Note: All performance calculations are based on AB Invest Capital per share book value and include dividends. Numbers are updated quarterly.
Comments on 2017:
2017 was an interesting year with net long positions in Equities, especially Private Equity, while holding plenty of cash. In spite of some early mistakes, our strategy was proven successful resulting in our best performance year ever.
As I reflect back on 2017 I would like to refer to my article "Cycle Analysis" written in March of 2017. If you are unfamiliar with the concept of Cycle Analysis, you can study this article on my LinkedIn page.
It is clear that the traditional economic cycle-analysis has been turned upside down during 2017.
Depending in where you look different parts of the market appear to be priced for substantially different parts of the 3 first phases in a cycle-analysis (Early-, Mid- and Late-cycle). With this unusual phenomena, investors have to decide whether there will soon be a return to the usual cycle or if they should rip up the playbook altogether and bet on Early-cycle indicators that are found by some investors.
Let’s take a closer look:
Most all would agree that the foundation for cycle analysis is the bond market, particularly flattening and widening of the yield curve—the gap between long and short-term bonds. Last year the gap between the 10- year and the 2-year Treasury equaled just half a percentage point. Last time this reported was when the US equity market peaked in October of 2007. Flattening of the yield curve normally suggests the economy’s moving into the Late-cycle nearing the fourth phase, which is Recession.
In 2017 the US Equity market sent a different signal though. Although Dow Jones beat the smaller stocks of Russell 2000, normal in Mid-to-Late cycle, performance was still led by high-growth technology companies and by consumer-facing businesses, which usually do best in the Early-to-Mid cycle. Under no circumstances were there any signs of a rotation into utility stocks usually popular in Late-phases of the cycle-analysis, being defensive against higher interest rates and weaker growth.
The economic data are confusing, too. Nine years of growth would suggest we are nearing Late-cycle growth with peaking demand. Instead, the Institute for Supply Management’s manufacturing index is surging, with new orders leading the way and no sign of a buildup of excess inventory, further signs of being early in the cycle-analysis. One explanation for the mixed signals is that bonds are distorted, but it also points to risks ahead. Long-dated bond yields are low partly because investors are convinced that interest rates will be permanently lower and inflation has been defeated. Low bond yields in turn make growth stocks—those with earnings far in the future—more attractive.
If inflation comes back or central banks become more aggressive, rising bond yields and higher rates together could hurt these long-duration stocks, and push shareholders toward defensive stocks with more reliable short-run earnings—late-cycle behavior. However, the cycle itself could be misleading. The U.S. economy is being lifted by the recovery of the rest of the world, much of which has experienced one or even two recessions since the last U.S. slump ended in 2009. Global growth, together with the falling away of concerns about China’s debt pile, helps explain the gains for metals prices, too. Maybe the U.S. is just a year or so into a new Early-to-Mid-cycle, likely to be further supported by corporate-tax cuts. If so, this cycle starts out with the advantage of low inflation but the disadvantages of already-low unemployment, high corporate debt and a Fed set on a tightening path.
Whether this is a new Early-cycle or a mixed-up Late-cycle, any hint of inflation is likely to prompt worries that the cycle is maturing, quickly pushing up bond yields and drive commodity prices higher as dark clouds start to emerge in the economic skies as they always do from time to time. The only thing we know for sure is that we don't know. Therefore, you may want to read my latest Article called Dollar-cost-averaging vs. Trying to time the Market, as this may be a better guide to the future.
We are pleased to report to our shareholders that we beat our benchmark index S&P 500 by +17.85% in 2017, much related to gains in our operating companies. We managed to deliver our best year yet in spite of a loosing about 3% in our short derivatives during the year. Our long term goal is to continue to beat S&P 500 by at least 10%-points which we believe we can do.
Anders J. Berggren
Chairman, AB Invest Capital
Copyright AB Invest Capital