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as of 12/31/18
Last quarter, we suggested several potential catalysts that could likely trigger a mean reversion where international equities would begin to outperform their U.S. counterparts. Such catalysts included indications of a credible truce between the U.S. and China on trade, market recognition that U.S. corporate profits and equities were quite exposed to disruption from escalating tariffs and foreign policy tensions, and finally, a peak in unconstrained executive privilege, or what we termed “peak Trump political currency.” During the fourth quarter, the above catalysts have all come into play, and as a result, international equities outperformed the U.S. for the first time in several quarters. We believe such outperformance is a welcome precondition to forming a durable bottom and a return to positive returns.
We now enter 2019 with various risks to U.S. corporate earnings increasingly priced in and speculative and leveraged positioning in equities, bonds and oil having corrected and normalized. Our conclusion is that much that could go wrong has been priced in, particularly in mid-cap growth stocks globally, which suffered an outsized correction in the fourth quarter. Consistent with the above conditions, as well as our view that the U.S. midterm elections might represent an important inflection point where we begin to see constraints on U.S. executive privilege, we became considerably less defensive and exited the quarter with a much-reduced cash position. In the near term, we believe a notable rally in international equities is more likely than a further decline, as markets begin to anticipate a de-escalation of protectionist measures and improving global trading conditions, as well as a more flexible Fed mandate. Such a development would likely suggest a peak in the U.S. dollar and further outperformance by international equities. While this is our base case expectation for now, we also maintain caution, as in our view the global capital markets will remain sensitive to the elevated risk of policy error.
While we believe unconventional U.S. foreign policy initiatives have driven international equity risk premium higher and earnings multiples lower in the short term, we are encouraged by several emerging bright spots. We believe we are nearing a conclusion to the Brexit drama, and suspect a near-worst case scenario is expected and largely priced into markets. During the quarter, we increased our domestic U.K. exposure and currently see both attractive risk/reward and a catalyst likely to emerge soon. Should the outlook for foreign and trade policy reduce pressure on China, and Fed policy shift to a marginally more accommodative stance, we believe many of our existing investments offer material upside from current levels. As always, we remain confident that our forward-looking and bottom-up fundamental approach positions us to discover exciting long-term investment opportunities regardless of the market environment.
as of 12/31/18
as of 12/31/18