Chevy Chase Trust
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The $26 Billion Woman Posted in: Featured, People - Read the Washington Business Journal’s feature on Amy Raskin, Chief Investment Officer, who is responsible for overseeing $26 billion in active and passive investments at Chevy Chase Trust.
Don’t just take our word for it. Posted in: Featured - At Chevy Chase Trust, we specialize in global research and thematic investing informed by careful planning, and it's working. Forbes and RIA Channel recently ranked us among the highest in their Top 100 list, for 2 years running. Important Disclosures
Chevy Chase Trust - Investment Update, Third Quarter 2017 Investment Update, First Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index began 2018 at 2,674. It ended the first quarter at 2,641. After accounting for dividends, the S&P generated a relatively small negative return of -0.76%.
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  • Chevy Chase Trust - Investment Update, Third Quarter 2017 Investment Update, First Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index began 2018 at 2,674. It ended the first quarter at 2,641. After accounting for dividends, the S&P generated a relatively small negative return of -0.76%.

    Macroeconomic Outlook — The S&P 500 Index began 2018 at 2,674. It ended the first quarter at 2,641. After accounting for dividends, the S&P generated a relatively small negative return of -0.76%. If you somehow managed to ignore the financial media between January 1st and March 31st and just looked at these numbers, you might think it was a fairly uneventful quarter. Alas, that was not the case. During the first quarter, the S&P 500 saw 23 daily moves of plus or minus 1% or more. This compares to a mere eight in all of 2017.

    2018 began with the highest level of bullish investor sentiment since 2010, as tracked by the American Association of Institutional Investors. In 2010, quantitative easing buoyed equity markets. In 2018, tax cuts and strength in the global economy formed the basis for optimism. The quarter began with the best January in eight years, but ended in the red for the first time since 2009. While earnings rose meaningfully, the market’s price-to-earnings multiple fell.

    In our opinion, equity market risk has increased in the past 90 days and the risk/reward trade-off for the next 12 months has shifted from favoring risk to a more balanced view. In the near-term, we would not be surprised by more market weakness and higher than normal volatility. Despite our fairly balanced view, we do look for what could go wrong. Below are three near to medium-term risks.

    1. A peak in global growth coupled with a more hawkish Fed – There is no imminent danger of a significant deterioration in global growth, but the rate of improvement is likely peaking. A more moderate pace of growth, in and of itself, would not be enough to cause an equity market sell-off. However, if it is coupled with a less accommodative monetary back-drop (i.e. continued Fed tightening), equity multiples will likely contract further. In this scenario, the decline in price-to-earnings multiple would likely more than offset positive growth in earnings. Under Janet Yellen’s leadership, it seemed unlikely that the Fed would press ahead with rate hikes if macroeconomic growth slowed appreciably. Under a new Chairman and with several Federal Reserve Board vacancies to be filled, the situation could be different. The Fed, as expected, raised rates in March despite recent financial market turbulence. Federal Open Market Committee participants revised upward their projections for both economic growth and the fed funds rate. Six participants now expect four rate hikes this year compared to only four in December. An overly hawkish Fed is still not our base case. We think when the preponderance of evidence shows economic growth slowing, the Fed will adjust its policy actions accordingly.
    2. Optimism and financial market instability – As mentioned above, optimism was at an eight year high at the start of the year. A simple word search on the terms “strong global growth” and “weak global growth” illustrates this extreme optimism nicely. Articles mentioning strong global growth shot up in frequency in late 2017, while articles mentioning weak global growth fell to their lowest level in a decade. A picture, or in this case a graph, is worth a thousand words.More recently, euphoria has faded in response to equity market weakness and volatility. Still, a majority of investors and economists seem focused on positive macroeconomic momentum and strong earnings growth, the logic being that bear markets and recessions go hand in hand and leading indicators are not pointing to a recession.While this analysis is sound on the surface, there is a possibility that a sufficient tipping point of financial market weakness and volatility could trigger a recession. Risk assets are now five times greater than global GDP. Causality doesn’t always run from the economy to financial markets. In major downturns, causality can run in reverse. Specifically, the last three economic downturns had their genesis in financial markets. The bursting of the bubble triggered the downturn of 2001; the large scale mispricing of U.S. mortgages caused the Great Recession of 2008; and the explosive widening of euro area sovereign credit spreads resulted in the euro area recession of 2011. We expect volatility to continue to shake out weak equity holders and reduce investor optimism. This will be good for future returns as long as it does not create panic and instability. Again, our base case is that market participants will cope with volatility and avoid a bear market, but the risk that volatility could reach a tipping point has increased.
    3. Rising protectionism – This risk is harder to analyze. We know President Trump faces few constraints in escalating protectionism. But we do not know whether he will actually pursue what would be a destructive path or if it is simply verbal posturing. A trade war with China would severely damage both countries, and in turn, world growth. Equity markets are likely to continue to negatively react to signs of increasing tensions, and positively react when rhetoric cools.
      In conclusion, we expect equity markets to continue to be volatile in the near term. If the Fed recognizes a slowdown in growth and reacts accordingly by slowing the pace of interest rate increases, it is not implausible that the bull market we have enjoyed for the past nine years resumes. However, if the Fed pursues an aggressive trajectory and/or trade tensions escalate, equity markets could drop below the February 9th low of 2,532. This “break” could scare technically focused investors and cause some algorithmic selling. In this scenario, it is possible that the S&P Index could fall 5-7% below the recent low. All other things being equal, we would view this as a buying opportunity.To reflect the increased risks outline above, we have rebalanced portfolios. We trimmed position sizes in several of our biggest winners, mainly technology related stocks, and increased more defensive holdings. This rebalancing has not reduced exposure to our themes and thematic holdings. When volatility rises, concentrating on our highest conviction investment ideas has served us well in the past and we believe it will do so now as well.


    Thematic Update

    The growing importance and systematic undervaluation of intangible assets has been an important and successful theme for Chevy Chase Trust. We have long believed that corporate balance sheets understate intangible investments. For the most part, spending on intangibles is treated as a current rather than a capital expense. In contrast, investments in tangible assets, such as machinery, trucks or warehouses, are capitalized on corporate balance sheets and depreciated over long periods of time. Understatement of intangible investment has led to undervaluation of intangible assets. Many intangibles, like non-public consumer data, research and development and large user networks are increasingly valuable but difficult to measure. These characteristics have provided opportunities to earn excess returns by owning intangible-rich companies.

    We recently read an insightful book, “Capitalism Without Capital: The Rise of the Intangible Economy,” by Jonathan Haskel and Stian Westlake. Over the past few decades, the nature of investment in many developed markets, including the U.S., has changed. As shown in the chart below, U.S. investments in intangibles, such as software, research and development, market research and branding, now represent a greater share of economic output than tangible investments.


    The authors describe how, in their opinion, intangible assets most critically differ from physical goods.

    • Intangible assets do not follow the same set of physical laws as tangible assets. They can generally be used over and over by different people in different locations, often at the same time. They are scalable in a way tangible assets are not. For example, a software package or a drug formulation can be used in offices or labs in multiple countries by multiple users at the same time. The same is not true for a piece of machinery or a delivery truck. Further, once a business has invested in creating or acquiring an intangible asset, it can usually reuse it continually at very little cost. This scalability allows intangible-intensive businesses to grow fast.
    • It is hard to recoup money spent on intangible assets if the investment is not successful. Physical assets are often easier to sell or repurpose if things go wrong. In contrast, investments in intangibles often represent sunk costs. This characteristic makes them much harder to finance, particularly with debt.
    • Ownership of intangible assets tends to be more difficult to establish legally than ownership of tangible assets. As a result, investments in intangibles are more easily copied by competitors. The company making the investment does not always reap the reward. In economic terms, the original investor may not appropriate the benefits of intangible investment. This characteristic tends to discourage corporate investment spending.


    These characteristics of intangibles help explain some perplexing relationships in today’s economy. As the authors explain, “one of the most troubling and widely talked about trends in economics at the moment is secular stagnation: the fact that business investment is stubbornly low despite every indication that it shouldn’t be.” In the past, when interest rates were low, investment spending increased. The greater uncertainty associated with investing in intangibles, and the increased difficulty in funding intangible investments, may at least partially explain the current breakdown in the relationship between interest rates and investment.

    Another unusual aspect is that corporate profits in the U.S. and elsewhere are, on average, higher than they have been in decades and seem to be steadily increasing. However, these profits are increasingly unequal. Normally, over time competition levels the playing field between leading and lagging firms, as profit margins regress to the mean and the laggards go out of business. This does not appear to be the case now. In part, this may be due to the scalability of intangibles and the ability of certain very large firms to dominate.

    While we value external validation of our thematic research, Capitalism Without Capital and similar articles put a focus on the theme and make it more likely that other investors will begin to fully value intangible corporate assets. When a theme is recognized by other investors, we benefit from being an early investor, but the future opportunity to earn excess returns diminishes. Some of our best performing holdings have been in companies with unique intangible assets. Some have doubled or tripled in price. Today, the valuation gap is smaller than it has been. We still think there are opportunities to invest in companies with undervalued intangible assets, but the opportunities are shrinking.

    We often get asked “when and why would we exit a theme?” One of our requirements for a theme is that we believe that other investors will begin to discount the theme in their valuation models within a reasonable time frame, which for us, is three to five years. We would not be surprised if within the next 12-18 months the valuation gap in this theme will have closed and the overall theme will have lost its advantage. Of course, we are always researching potential new themes.


    Fixed Income

    Similar to equity markets, the first quarter of 2018 was tumultuous for fixed income investors. U.S. 10 year bond yields started 2018 at 2.41% and rose rapidly to a high of 2.95% on February 21st. Since late February, equity market volatility and protectionist policies led investors to seek safety in bonds, causing yields to recede about 20bps (0.2%) to close the quarter at 2.74%. Of course, rising yields means falling prices. Interestingly, shorter term bond yields followed a similar trajectory. Two year Treasury yields started the year at 1.88%, rose to 2.34% on March 20th, and receded to close the quarter at 2.26%.

    One of the more consensus views beginning the year was that rapid global economic growth would lead to meaningfully higher bond yields. Most economists predicted that 10 year U.S. bond yields would exceed 3.0% or even 3.5% by year-end. We have been more conservative in our estimates (more optimistic on prices), and still believe consensus expectations are too high. That said, a trade war or change in foreign appetites for U.S. debt could meaningfully impact prices. These risks are difficult to handicap.

    We continue to view high quality, shorter-term bonds with ample liquidity as the most prudent investment option in volatile markets.

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  • Q & A with Tap Chibaya - Chevy Chase Trust Noteworthy Q & A with Tap Chibaya Posted in: Noteworthy, People - We recently sat down with Tapfuma Chibaya, an Equity Research Analyst at Chevy Chase Trust, to learn more about his background and what he enjoys most about his career. 

    We recently sat down with Tapfuma Chibaya, an Equity Research Analyst at Chevy Chase Trust, to learn more about his background and what he enjoys most about his career. 


    Give us a brief rundown of a typical day for you at Chevy Chase Trust.

    I arrive around 8:30 am, before the markets open at 9:30. This gives me time to go through emails and news, and catch up on anything that may have happened overnight. Since we invest internationally, lots can happen overnight.

    After that, the first half of my morning is typically research. Checking any new articles that provide new waves of thought that may affect what we are doing here investment wise. Other than these important aspects of my day, it is hard to define a typical day, because there are often many different projects going on at once.


    In summation, what is your responsibility for CCT?

    To put it simply– my job is to come up with good, investable ideas for Chevy Chase Trust, that will ultimately help our clients meet their investment objectives.

    I compile materials to build a case for each idea and then try to convince our research team that it is worthwhile. The best way to do this is just keeping an ear to the ground. I pay attention to all of the trends and have to stay ahead of what’s currently happening.


    Tell me a little about your background.

    I grew up in Zimbabwe, in a very small community. There were no more than 5,000 people. My dad worked in a mining plant, and that plant was essentially the center of all activity in our town. The plant shut down, but I was fortunate enough to have two working parents, and my mom, a teacher, basically became the breadwinner.

    I attribute all of my success to my parents. They made sure to send me and my siblings to great schools, even at a sacrifice to themselves. Education was highly valued by my family, and I benefitted as a result. While still in high school I caught a lucky break, and I was given the opportunity to come to America.


    Did you go to college here?

    I went to college in Middlebury, Vermont through a program sponsored by the American Embassy in Zimbabwe. The program sought out students who showed promise and assisted us in the entire college application process. They even helped us determine the best schools to apply to, based on tuition assistance knowing that was something we would need. Each year roughly 20-30 students go through the program, and I was fortunate enough to be one of them.


    What was college like for you?

    Middlebury is a small liberal arts college, and I really enjoyed my time there. I majored in economics, but liberal arts was a new concept for me. In Zimbabwe, you specialize as early as high school, so I had already been on the business track for a few years. In the liberal arts setting, I was taking all kinds of classes… different types of history and music, etc. It was such an interesting experience for me, and if I had to do it all over again, I absolutely would.

    I was able to pick up some critical thinking skills that many people may underestimate, and I have an understanding of such a wide range of topics now, thanks to my college studies.


    Any courses you had to take that you surprised yourself by really liking?

    I ended up taking Spanish to nearly the highest level. There aren’t many African countries that speak Spanish!


    What was your first job after college?

    My first real job after college was as an equity research analyst at Credit Suisse, which I suppose explains why I am sitting in this seat today. It’s where I cut my teeth in the industry.

    Coming out of college I did want to be an investment banker. My finance professor was a former investment banker, and it was such a highly sought after career. I was enamored with the idea of it. But, as an international student, there were limitations on my job opportunities. It came down to finding a company where I fit, but who was also willing to sponsor me as an immigrant.


    Did you enjoy the research side more than you expected?

    I really did! It is so intellectual and I value that a lot. You can take the research wherever you want. Equity market research specifically fascinates me because it’s all public information—everyone has access to it, so it comes down to piecing together all of these individual parts to establish and support your ideas – i.e. the mosaic theory.

    After three years at Credit Suisse, I did test the waters as an investment banker but ultimately decided to come back to research. I personally found it a better fit and more intellectually stimulating for myself.


    What do you enjoy most about your career?

    Reading and learning new things. I try to learn something new every day or to enhance the knowledge that I already have.


    What do you enjoy most about working at Chevy Chase Trust?

    The people–especially the team I work on. I can see that my ideas are heard and that my work is valued. Chevy Chase Trust is unlike any place I have ever worked before. There’s also so much room for growth here—career-wise and as a person. It’s really a special place.


    What is the best lesson you’ve learned over your career?

    Do your work 100%, 100% of the time. Whether you have a small assignment that you feel is a waste of your time, or a big project that you feel will get you noticed. Do your work to the best of your abilities always. Don’t worry about who’s noticing, someone is always noticing.


    What is your favorite thing to read outside of work?

    Give me a John Grisham book, and I will read it front to back in one sitting!


    Tell us about how you spend your time outside of work.

    I spend a lot of time with my wife, checking out new restaurants or cooking ourselves. I also love to play soccer and am on a team nearby. Recently, I have been spending a lot of time in the gym just to stay healthy and mentally focused!


  • Amy Raskin, featured speaker at Strategas 12th Annual Macro Conference - Chevy Chase Trust Noteworthy Amy Raskin, featured speaker at Strategas 12th Annual Macro Conference Posted in: Insights, Noteworthy - At the Strategas 12th Annual Macro Conference on March 1, 2018, Chevy Chase Trust’s Chief Investment Officer, Amy Raskin, presented her views on Thematic Investing.  

    At the Strategas 12th Annual Macro Conference on March 1, 2018, Chevy Chase Trust’s Chief Investment Officer, Amy Raskin, presented her views on Thematic Investing.

    The conference, which highlights important investment trends driving the economy and markets, featured a panel of eight experts in the areas of Thematic Equity Investing, Cryptocurrencies, Japan and Growth Stocks.

    Raskin’s presentation focused on “the modern version” of thematic investment approach which has gained visibility in recent years. While thematic investing is just 15-20 years old, Raskin pointed out that it is a throwback to investing in a simpler time—before there were 115 different mutual fund categories. She defines thematic investing as “an investment style that seeks investable ideas that stem from economic or technological changes that are powerful enough to influence corporate performance across multiple industries.”

    Distinguishing themes from trends, Raskin emphasized that of the many profound changes occurring around the world, most are trends, not themes since they are not likely to  add to the bottom lines of investable companies. She offered two examples of current themes at Chevy Chase Trust including molecular medicine – the revolution in medical treatment created by detecting small variations in the human genome that can cause disease, and the U.S. wealth migration toward urban areas –the movement of wealthy people in the U.S. to cities, partially reversing the suburbanization trend of the previous 100 years.

    In the end, Raskin said her thematic investing approach tends to result in a broadly diversified global portfolio that doesn’t expose clients to big swings in the business cycle and skews to the US, because, for structural reasons, that’s where a disproportionate share of the most innovative and disruptive technologies is created.

  • Investing in Disruptive Change: The Great U.S. Wealth Migration - Chevy Chase Trust Noteworthy Investing in Disruptive Change: The Great U.S. Wealth Migration Posted in: Insights, Noteworthy - As thematic investors, we look for phenomena that are transforming economic prospects across multiple industries. Here we discuss one of these phenomena, the migration of U.S. wealth to urban areas, and some of the investment implications.

    As thematic investors, we look for phenomena that are transforming economic prospects across multiple industries. Then, we seek to identify companies that will benefit, are investable through public equities with ample liquidity, and are likely to pay off within three to five years. Here we discuss one of these phenomena, the migration of U.S. wealth to urban areas, and some of the investment implications.

    For the first time in over a century, more people in the United States are moving to cities than to suburbs. The educated and affluent are opting for walkable cities with restaurants, shopping, schools and parks easily accessible via sidewalks and bike paths. In contrast, moderate and low-income people are leaving cities, often priced out by rising rents.

    This wealth migration to cities is the result of lifestyle preferences that are favoring urban amenities over suburban space.   This shift is being reinforced by contemporary urban planning and secular economic trends, including the migration of businesses to urban areas with highly educated workforces. We believe these trends will continue for decades, with urbanization spreading outward from city cores, turning many suburbs into urban-like villages.


    American Exceptionalism

    Urbanization is a centuries-old global trend that has accelerated in recent decades. China’s population is now approximately 50% urban, up from 16% fifty years ago, but it’s still well below that of Western Europe and Latin America. By some measures, the U.S. is the most urbanized country in the world, with 80% of its population living in metropolitan areas. But by another measure, the U.S. is far less urban than most developed countries. More than 60% of the U.S. population lives in close-in suburbs that are part of metropolitan areas. This development pattern is virtually unique to the U.S. and largely the result of government policies.





    The American Dream of home ownership was created by the Federal Housing Administration in the 1930s and propelled forward after World War II by the Veterans Administration home loan program. Then, the creation of the interstate highway system in the 1950s, coupled with low gas prices, made suburb-to-city commutes both easy and affordable. A final suburban push came in the 1960s, as safety fears stirred by urban riots dominated headlines and television screens. Rising crime rates prompted people with the means to live elsewhere to leave cities for the safety of the suburbs. The population of most U.S. cities fell in the 1960s and 1970s, leaving cities poorer and more racially segregated. But migration to cities resumed in the 1980s and has sped up over the last 15 years, finally outstripping the slowing rate of net migration to suburbs. Now, urban population growth is being driven by high earners and the highly educated. As city rents rise, lower income people are leaving, priced out by rising rents and rising home prices.


    Today, the U.S. is becoming a more urban society and cities are becoming wealthier. These trends are reinforcing each other in a virtuous cycle, with falling crime rates making urban living more desirable, new approaches to urban planning fostering walkable neighborhoods with dining and shopping, an educated and youthful population developing a taste for the new urban lifestyle, and companies, particularly knowledge-based companies, moving to be near pools of talent. The clustering of people, talent, firms and capital has spurred innovation and increased productivity, turning cities into incubators of economic development.


    Falling Crime Rates

    Cities have become safer. New York City reported 2,000 violent crimes per 100,000 people per year, on average, in the 1980s, but only 600 per 100,000 between 2008 and 2014. Other cities reported similar, though smaller, drops. In aggregate, violent crime rates in large cities have declined by one-third over the last decade. In contrast, crime rates in suburbs have risen 17% on average, with drug-related crimes accounting for most of the increase. Safety improves quality of life.  With urban crime rates falling and suburban crime rates rising, suburbia is losing one of its long-held advantages.


    The New Urban Planning

    For decades, cities across the U.S. have been making concerted efforts to attract young, educated, and higher-income people, and the companies that employ them. In the 1980s, New York redeveloped the South Street Seaport and Boston revitalized Quincy Market into charming old-fashioned shopping and dining districts attracting new residents and more visitors. This trend predates Millennials’ current love affair with cities.  We think it is likely to endure for this and future generations.

    The new urban planning models focus on being pedestrian friendly. Sidewalks are a priority and neighborhoods are re-zoned so that residential, retail, office buildings, schools, and recreational facilities are within compact areas. According to a study by Redfin of the Washington, D.C. metro area, walkability pays off in higher real estate values. A 20-point increase in a walkability score translates into a $9 per square foot premium in office rents, $7 premium in retail rent, 80% increase in retail sales, a $300 per square foot premium in residential rents, and an $80 per square foot premium in residential housing prices.

    Biking, too, has become a priority as it has grown in popularity. Newer urban planning models include bicycle trails and bike sharing systems, which provide another transportation option for young professionals less keen on driving. Chicago saw its investment in biking correlate with its rise as a global startup destination. “You cannot be for a startup, high-tech economy and not be pro-bike,” Chicago Mayor Rahm Emanuel has said.


    Smart urban planning allowed New Orleans to make its comeback after Hurricane Katrina. The city devised a master rebuilding plan focused on three key goals: walkability, new business formation, and sustainable development using green technology and better transportation planning. The plan worked. In 2014, a boom in start-up activity resulted in New Orleans having new business formations 64% higher than the national average.

    Suburbs like Bethesda, Maryland and Palo Alto, California have adopted similar urban planning measures to become walkable urban villages clustered around big cities. Increasingly, these wealthy, urban-like suburbs centered around transportation hubs extend urbanization outward. Suburbs without such amenities, by contrast, face a decline in population, jobs and tax revenues. As a result, they may soon be forced to cut services, as some cities and rural towns have been forced to do.


    Not Just Demographics

    Some observers dismiss the wealth migration to cities as the temporary result of a demographic bulge that will reverse as Millennials mature and choose to raise their families in the suburbs, as their parents and grandparents did. We agree there is a demographic factor at work here, but we think that Millennials are less likely to leave cities than previous generations, and those who do leave will likely move to urban-like suburbs.

    Millennials, the generation born between 1981 and 1997, include some 47 million people and about 30% of the U.S. workforce. Having come of age during the last two recessions, many Millennials had difficulty starting a career.  Many are also saddled with student debt. Both factors make it challenging to afford a family or buy a home. Largely as a result, homeownership for people under age 35 has fallen sharply from its peak in 2004.



    Today, first-time homebuyers have been living in rental apartments for six years on average, longer than at any time in the last 50 years and more than double the average during the early 1970s.  And Millennials are just the latest of several generations to wait longer to marry and start a family. The average age of first marriage and childbirth has been rising for nearly 50 years.

    The revival of once blighted cities started in the 1980s, when falling crime rates and de-industrialization began to make many cities safer and cleaner. Young professionals pioneered the gentrification of urban neighborhoods such as New York City’s Upper West Side, Boston’s Back Bay, and Washington, D.C.’s Capitol Hill, in the 1980s and 1990s. Many of those young professionals stayed to raise families because they liked walking their children to school and stopping at a neighborhood cafe on the way home. Similar lifestyle shifts occurred in cities across the nation in subsequent decades as people sought shorter commutes and city planners designed mixed use developments of retail, housing and commercial space, creating true live, work, play environments.


    Jobs Follow Talent

    Both new and established companies want to be located near clusters of talent. As talented young professionals show a preference for cities over suburbs, companies are following.

    • Rolls-Royce moved 2,500 employees from six primarily-suburban locations to a single downtown office in Indianapolis in 2011, to meet the wishes of students coming out of engineering school. These students were “looking for the downtown living environment,” according to a company report.
    • Forty-four years after leaving New York City for a 70-acre suburban office park in Fairfield, Connecticut, GE will relocate its headquarters to downtown Boston in 2019.
    • McDonald’s is moving its headquarters from a suburban office park in Oak Park, Illinois, to downtown Chicago.
    • Marriott is moving from a suburban office park with limited public transit to downtown Bethesda, Maryland, adjacent to the metro rail and just outside of Washington, D.C.
    • Amazon’s announcement in 2017 that it was seeking a second headquarters specified that it wanted to locate in a metropolitan area with a population over one million, strong technical talent, and access to mass transit.


    The Knowledge-Based Economy

    The service and technology sectors, often referred to as “knowledge industries,” continue to power the U.S. and global economies. Companies in these industries are increasingly city-based.  More than half of new companies with at least $1 billion in market value are headquartered in downtown San Francisco or New York City.  Most are tech firms.

    An analysis of new business formations after cyclical downturns shows how this trend has evolved. Smaller cities and rural areas drove the economic recovery in the 1990s, together creating roughly 70% of new business formations. By contrast, in the 2000s recovery, large cities created 50% of U.S. jobs, as the tech-driven economy took off and suburban office parks began to decline. And in the most recent post-financial crisis recovery, large cities fueled four out of five new business formations and accounted for 60% of all new jobs, while new business creation in rural areas has stagnated.



    Investment Considerations

    The U.S. wealth migration to cities has investment implications that span sectors and industries. By studying this shift, we can better understand the evolution of new business models designed to take advantage of higher-density living, and assess the opportunity set of companies poised to benefit from these secular trends.

    • A decade ago, we sought to invest in the growth of cities in emerging markets, particularly China. Our investment ideas back then centered on materials, infrastructure and manufacturing. In contrast, our current investments in the migration of U.S. wealth to urban areas are tilted toward technology, data and services.
    • American consumers spend $13 trillion per year. Investment opportunities arise from understanding where and how that money will be spent. The answer to ‘where’ lies increasingly in urban areas.
    • Urban dwellers now earn 30% more than their rural counterparts. With incomes and spending growing faster in urban areas than in America overall, we project that spending per square mile in urban areas will increase by 40% in 2020.
    • Urban consumers spend differently than their rural counterparts. They spend more on housing, education, clothing, cosmetics and food outside the home—and far less on cars and transportation.
    • New business models are emerging that capitalize on the concentration of people and wealth in urban areas. Many of these businesses focus on convenience and choice. Delivery businesses will continue to evolve for food and consumer goods; and mobility services, such as ride-sharing, will transform transportation.
    • Older infill industrial properties will become increasingly valuable for redevelopment as fulfillment centers for e-commerce firms. At the same time, new retail construction will decrease as store footprints shrink. We expect a 5% to 10% contraction in retail square footage, with each one percent being the equivalent of 1,800 football fields.
    • Significant chunks of suburban commercial real estate are likely to lose value, unless they find ways to become destinations. Strip malls and big box retailers appear most vulnerable.

    In sum, the wealth migration to urban areas with distinct amenities is defining a growing ecosystem that we think will spawn innovative new economic activities for years to come.


    Download the white paper here. 

  • Saying economy is strengthening, Fed’s Powell suggests faster pace of interest rate hikes - Chevy Chase Trust Saying economy is strengthening, Fed’s Powell suggests faster pace of interest rate hikes Posted in: Insights, Noteworthy - From The LA Times: During his first Capital Hill appearance since taking over as Fed Chair, Jerome H. Powell suggested Tuesday that the central bank could hike its key interest rate faster than anticipated. Craig Pernick, Head of Fixed Income weighs in.

    New Federal Reserve Chairman Jerome H. Powell indicated Tuesday that the economy’s prospects have strengthened and that the central bank could lift short-term rates at a quicker pace than anticipated. Speaking before the House Financial Services Committee, Powell said, “We’ve seen some data that will, in my case, add some confidence to my view that inflation is moving to target. We’ve seen continued strength around the globe and we’ve seen fiscal policy become more simulative.”

    Craig Pernick, Head of Fixed Income, commented, “He is saying more of the same, but he’s saying it with a tone with words like ‘tailwinds’ instead of headwinds and that the outlook remains strong.”

    Read the full article here.

  • Finding Opportunity in Disruptive Change: Retailing and Its Supply Chain Posted in: Insights, Noteworthy - As thematic investors, we look for phenomena that are transforming cash flows and profitability across multiple industries. Here, we discuss one of these phenomena—how the next generation of automation is impacting the retail industry. 

    As thematic investors, we look for phenomena that are transforming cash flows and profitability across multiple industries. Then, we seek to identify companies that will benefit, are investable through public equities with ample liquidity, and likely to pay off within three to five years. Here, we discuss one of these phenomena—how the next generation of automation is impacting the retail industry.

    More than 20 major U.S. retail chains declared bankruptcy in 2017, from Sports Authority and Toys ‘R’ Us to Payless ShoeSource. Thousands of stores closed, more than in either of the recession years of 2001 and 2008. Yet, retail sales are booming, the economy is strong and unemployment is at a low of approximately 4%. What’s going on?



    First, e-commerce is taking an ever increasing share of the $3 trillion in U.S. retail spending. E-commerce already accounts for more than 13% of retail spending and should more than double over the next ten years.

    E-commerce’s growth and increased market share occurred against a backdrop of an already bloated retail sector. Retail square footage per capita rose by more than 50% in the U.S. from 1970 to 2016. As a result, according to PricewaterhouseCoopers, there was more than five times as much retail square footage per person in the U.S. than in Europe.



    Brick and mortar retailers are responding by trying to move online themselves and adopting new, small-store formats to reduce costs and get closer to consumers. This is reversing the long-term trend toward big box stores.

    Concurrently, a new generation of automation is upending the global supply chain, rearranging the logistics of retailing and changing the cost structure throughout the supply chain. Production and fulfillment centers are moving closer to the end consumer, reversing another long-term trend toward globalization of production.

    Most warehouses today look much like they did 100 years ago, cavernous buildings filled with stacks of crates, shelves, pulleys and lifts. The process inside the warehouse is still largely manual. Five years ago, workers at a typical Amazon warehouse walked up to 12 miles a day, pushing a cart, locating items, taking them from shelves, and moving them to a packaging station.

    Automating Warehouses and Fulfillment Centers

    That’s changing. Amazon now has over 100,000 mobile robots operating inside fulfillment centers. These robots lift entire shelves and bring them to packaging stations, eliminating the need for pickers to walk the aisles locating items. Amazon’s new warehouses have miles of conveyor belts, automated shuttle systems and cameras that can read 80 barcodes per second.

    Robots move faster, maneuver through narrower aisles, and retrieve goods from shelving up to five times higher. These changes have resulted in a 20% reduction in operating costs. As a result, there is a growing cost and efficiency advantage of e-commerce over traditional brick-and-mortar stores. In 2012, Amazon sold seven times more merchandise per square foot of real estate than the average brick-and-mortar store. Since then, warehouse automation has boosted Amazon’s efficiency premium to nine times the average of traditional stores, which have also become more efficient but are falling farther behind.



    While Amazon continues to expand its robot fleet, it is also developing a next generation robot that can open boxes, identify and remove single items, and place those items in a different box. At an Amazon-hosted robotics contest in 2017, a robot that picked up a baby wipe was treated like a rock star. The celebration of this feat and the tasks being designed for the next generation of robots are examples of Moravec’s paradox. Hans Moravec, a futurist at the Robotics Institute of Carnegie Mellon University, determined that it was relatively easy for robots to be programmed to perform complex adult-like computational tasks, but much harder to replicate the simplest tasks of a toddler, like walking without falling, avoiding a misplaced piece of furniture, or placing a square peg in a square hole.

    This next generation of automation will use cameras, sensors and software to enable robots to perceive and respond to their environment. They will operate around the clock in a “lights out” warehouse without the need for lunch breaks, vacations, sick days, or overtime.


    Last-Mile Production & Delivery

    Next-generation automation is also allowing consumer goods companies to speed time to market. Apparel companies today typically place orders as much as a year in advance—which doesn’t align well with constant demand for current fashion and customizable options. Nike says that the inability to react quickly to demand signals can result in hundreds of millions of dollars of lost profits. Today, most footwear and clothing are produced in Asia by a multitude of contractors and subcontractors. A shirt might be stitched in one factory from cloth woven, dyed, and cut in three separate factories owned by three different companies, with time between each step of production.

    This system evolved to cut labor costs, which in Asia can be as little as one-tenth the labor cost in the U.S. Automation makes it possible to locate production closer to the end consumer. While labor costs in developed markets are higher, the cost is more than offset by reduced transportation costs, faster time to market and the need for fewer workers. An Atlanta-based company is producing automated sewing equipment for a t-shirt factory. The company claims its first-of-a-kind technology reduces labor by 90%, while nearly doubling output per hour. Similarly, Nike and Adidas have announced plans to use 3D printing and robotics to produce footwear and apparel here in the U.S. Nike already allows shoppers to order sneakers with customized features.

    Amazon was recently granted a patent for equipment that uses a customer’s measurements to make personalized clothes in their fulfillment centers. To complement this strategy, it also purchased a company that makes highly accurate 3D models of each customer’s body. Executives who enjoy the convenience of being measured in their o ce for custom-made suits, typically wait weeks, if not months, for tailoring and delivery from Hong Kong. Amazon’s new system may soon provide custom-tailored suits faster.

    E-commerce is also gaining market share by providing next-day and same-day delivery in major metropolitan areas. To provide this convenience, Amazon, Best Buy, and other e-tailers are locating fulfillment centers closer to the customer, typically in higher-cost urban and suburban areas, rather than rural industrial parks.



    Amazon fulfillment centers are, on average, 60% closer to purchasers than they were a decade ago, yet still over 100 miles away. In Amazon’s top 25 markets, its fulfillment centers are almost three times closer to the end consumer than in smaller markets. Locating distribution centers 10 miles, rather than 100 miles, from consumers could reduce e-tailers’ transportation costs by 70%. We estimate that close-in fulfillment centers have the potential to reduce overall e-commerce logistics costs by another 30% over the next few years.

    Eventually, e-commerce delivery costs will come down even more. Ruffaello D’Andrea, the co-Founder of Kiva, estimates that it will cost twenty cents to deliver a package with a drone compared with $2 to $8 per package for human delivery today. McKinsey & Co. projects that 80% of packages will be delivered autonomously by 2025.


    New Store Formats

    The increased cost advantages that e-tailing, automated warehouses and last-mile fulfillment have provided to e-commerce is putting some traditional retailers out of business and reducing new store construction. Retail construction fell 20% in 2016. We expect to see a 5% to 10% net reduction in retail space over the next few years. But, in our view, it won’t spell the end of brick-and-mortar stores. People still like going to stores to see displays, discover new products, touch fabrics, try on clothes, and interact with an in-store expert. These are unique advantages that traditional retailers can build on by enhancing the shopping experience, while slashing real estate and inventory costs.

    To cut real estate costs, retailers are reducing or eliminating in-store inventory. We expect retailers to reduce inventory by nearly $200 billion, or up to 30%, over the next few years. One strategy is to maintain better information on inventory levels with Ultra High Frequency Radio Frequency Identification (UHF RFID) chips. Think of UHF RFID as bar codes that don’t require a carefully positioned reader. The chips send out a radio signal that informs the store’s inventory system exactly how many units of each item are on the premises.

    Lululemon uses UHF RFID to enable customers to see real-time inventory levels in nearby stores on a mobile app; it also uses the data to balance inventory across its store network. Levi’s tags every pair of jeans with UHF RFID so stores can nd and sell scattered units during a big sale. This reduces odd lots the store would likely sell at clearance prices. We believe these strategies can boost revenues by 5%. For a store with 10% operating margins, boosting revenue by 5% without increasing costs could increase operating pro ts by 50%.

    Other stores are exploring other approaches. Target has a trial store with some goods for sale, but no backroom inventory. Target treats the store like an e-commerce customer, delivering goods as needed from nearby fulfillment centers.

    Wal-Mart, which built its empire on a low-price, low-service model, recently paid $310 million for Bonobos, acquiring a radically different way of doing business. Bonobos calls its stores “guide shops” because a trained guide introduces shoppers to its range of products and ensures that their personal tastes are met. Its shops have no inventory on site; orders arrive at the customer’s home two days later. Similarly, Nordstrom recently introduced Nordstrom Local, just 2% the size of a typical Nordstrom, offering personal shopping guides and amenities like a nail salon, but no on-site inventory.

    We expect the retail store of the future to be small and uncluttered, and to offer personal shoppers, customized goods, and home delivery. Think of it as a return to bespoke neighborhood tailors—or the spread of luxury service à la Bergdorf Goodman but at much lower prices. The same next-generation automation now being used by e-tailers to put brick-and- mortar stores out of business will allow brick-and-mortar stores to reinvent themselves and provide a more desirable shopping experience.


    Investment Implications

    Within the theme of next generation automation, many traditional elds and old-line business models are being disrupted. New business models are being created, some existing business models are being reinvented, and others are being subjected to creative destruction.

    The impacts on the retail industry and its supply chain are profound and become the catalyst for even more changes. Importantly, the investment opportunities are diverse, seemingly unrelated, but connected by the threads we see in secular trends and our thematic research.

    Here are some conclusions that shape our investment thinking:

    1. Emerging markets will lose an advantage over developed markets, as low-cost wages are no longer the determining factor in location of production facilities.
    2. Automation utilizing artificial intelligence and sensors will lower prototyping and small batch production costs, facilitating mass customization.
    3. Outsourced fulfillment will allow small brands and retailers to do what they do best, create unique products and connect with their customers, leveraging third-party supply chain infrastructure.
    4. Just-in-time inventory enabled by sensors, software, and local fulfillment will reduce inventory, waste, and overhead, and the need for pro t-destroying clearance sales.
    5. Mobile and alternative payment systems will continue to gain share as consumers move away from in-store cash transactions.
    6. These trends are deflationary as production costs decline and labor and real estate are repurposed.
    7. Shoppers will make fewer trips to physical stores, but when they do go, their intent to purchase will be higher. This will increase spending per visit and reward those retailers who can satisfy visitor expectations.

    In sum, we’re in the early stages of a revolution in retailing that is creating compelling new investment opportunities.


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  • Q & A with Marc K. Wishkoff - Chevy Chase Trust - Noteworthy Q & A with Marc K. Wishkoff Posted in: Noteworthy, People - At Chevy Chase Trust, Marc oversees the delivery of Chevy Chase Trust services to clients and coordinates with their legal, accounting and other third-party advisors.

    Marc Wishkoff, Managing Director

    Marc Wishkoff joined Chevy Chase Trust as Managing Director in 2009, coming to us from Citi Private Bank where he was Director and Private Banker.  At Chevy Chase Trust, he oversees the delivery of Chevy Chase Trust services to clients and coordinates with their legal, accounting and other third-party advisors. We sat down with Marc to find out more about how and why he pursued a career in wealth management and what he does in his spare time.

    Tell us about your background?
    I’m the oldest of three kids with two younger brothers. I have spent most of my life along the east coast of the United States and grew up in Wilmington, Delaware. I am a graduate of the University of Delaware, and the majority of my career has been spent in New York City and the Washington, DC metropolitan area.

    From where did your interest in the financial world come?
    From an early age I had an interest in business, banking and financial markets. My father worked for DuPont for many years as a chemical engineer, but always had an interest in the stock market. I can still remember copies of ValueLine Investment Survey and Investor’s Business Daily laying around the house. My great-uncle’s ownership of a business made an impression on me, as well as the businesses of several other relatives, and led me to want to study business in college.

    At the University of Delaware I obtained a degree in business administration with a concentration in finance. My career has been singularly focused in investments, banking and finance since.

    What was your first job?
    I worked from an early age and can hardly remember a time where I wasn’t doing something at least part-time. From about the age 13 and throughout high school I almost continuously had a job after school or over summers. In college, I worked in the restaurant industry as a waiter and towards the end of school as a credit analyst for a credit card company.

    In my junior year of college, I interned with Dean Witter and quickly learned that I didn’t want to be a broker. Starting the summer after college graduation, I worked for PNC Bank in the group that did accounting work for the mutual fund industry. In this position I worked closely with a New York City based asset manager, so much so that I was eventually hired by them directly and moved to New York.

    When did you move to wealth management?
    At Warburg Pincus Asset Management, I quickly identified where I wanted to focus my career. I was drawn by the intrigue of each private client’s personal story and business acumen. I eventually uncovered an opportunity to work directly for the partner in charge of marketing and I never looked back. At the end of 2000 after Warburg Pincus Asset Management had been through two corporate sales, I was presented with an opportunity to join an energetic group of people building a wealth management business in Washington, DC.

    U.S. Trust had just been acquired by Charles Schwab and I moved to the D.C. area to help open the Tyson’s Corner office and market our firm through our parent company’s offices in D.C., Maryland and Virginia. I had great support from dynamic local leaders and was surrounded by an amazing team of people who provided me with great help and resources. I worked with many of the Schwab brokers and learned how together we could build the brokerage and wealth management businesses to fuel the expansion of US Trust.

    At Chevy Chase Trust, I’ve utilized my many years of experience to ensure my clients not only understand their situation but then deliver to them the very best customized solutions our firm has to offer. If a client needs something we don’t do in-house, my long-standing relationships in the professional community make it easy for me to connect them with the right people and solve their needs. I act as a bridge between clients and the people they need to know both in our firm and outside in the community.

    What do you enjoy doing when you’re not at work?
    I am blessed with an amazing wife and family and the majority of my time outside of work is spent keeping up with the frenetic pace of a busy young family. We are big baseball fans and are active in local baseball and softball leagues and rooting for our Washington Nationals.

    We are also a beach family and enjoy frequent trips to Bethany, Rehoboth and Fenwick Island.

    I very much like to be active in the community and serve on the board of the Community Foundation for Northern Virginia. I am also a graduate of the 2014 class of Leadership Fairfax.

    If you weren’t in wealth management at Chevy Chase Trust, what would you be doing?
    I would probably be driving carpool – and thinking about how easy those people in wealth management have it.


    Continue to Marc Wishkoff’s biography

  • Downsizing baby boomers face a key decision: Is it better to rent or to buy? Posted in: Insights, Noteworthy - From The Washington Post: The age-old question of whether to rent or buy is prominent on the minds of baby boomers who are contemplating downsizing. Laly Kassa, Managing Director, weighs in on the topic.

    The age-old question of whether to rent or buy is prominent on the minds of baby boomers who are contemplating downsizing. Laly Kassa, Managing Director at Chevy Chase Trust, points out that many people assume buying is the better financial choice, but after she works through all the considerations with her clients, they often opt to rent—at least initially.  “I do encourage people to take their time with this decision and to rent temporarily if they are uncertain about their choice of where to live,” says Kassa.

    While many baby boomers envision downsizing to walkable neighborhoods in or near the city, they are surprised to find the costs are not always less than those of the suburban home they want to leave behind.  “There’s no right or wrong answer — you just need to line up the choices and decide what works for you psychologically and financially,” says Kassa.

    Read the full story here.

  • Why is Walmart Closing Sam’s Club Locations Around the Country? Posted in: Insights, Noteworthy - From The Street: Bobby Eubank, Thematic Research Analyst, provides insight on the closing of Sam's Clubs stores across the country and its affects on the retail supply chain model.

    Despite the closing of 63 Sam’s Clubs across the nation, Bobby Eubank, Research Analyst at Chevy Chase Trust, believes “It’s likely that Walmart will retain Sam’s Club. Retailers as a whole are constantly reviewing their portfolios, and right now there’s just too much retail square footage.”  Three Quarters of the stores that closed are located within 10 miles of a Costco.  According to Eubank, the Sam’s Club ecommerce revenue growth doesn’t compare favorably with Costco Wholesale Corporation’s. “Both Sam’s Club and Costco get that e-commerce is important,” Eubank told TheStreet, but Sam’s Club is still playing catch-up. While initially a dozen of the closed stores will serve as fulfillment centers for Sam’s Club’s online purchases, in the future all integrated Walmart brands may be served by these properties.

    Read the full article here.

  • Chevy Chase Trust - Investment Update, Third Quarter 2017 Investment Update, Fourth Quarter 2017 Posted in: Investment Update, Noteworthy - 2017 was an extraordinary year for stocks. The S&P 500 generated a total return of 21.8%, and rose every single month of the year.

    Enjoy It While It Lasts — 2017 was an extraordinary year for stocks. The S&P 500 generated a total return of 21.8%, and rose every single month of the year. Declines were small as the market set record after record. The largest peak-to-trough decline was a mere 3%; since the S&P 500 was created in the 1950s, there has been only one year, 1995, with a smaller intra-year drop. The index reached a new all-time high on more than one in four trading days, more frequently than in all but a single year, also 1995.

    Volatility was low. Breadth was strong. The only people who did not enjoy the U.S. market performance in 2017 were those on the sidelines and those betting against the market.

    Many of the year’s positive trends started earlier. Despite the long-held and widely shared view that equity investors should expect low returns, the S&P 500’s annual return has averaged above 15% for the past five years.

    All good things must come to an end–but not necessarily soon. Given the remarkably steady advance in 2017, the risk of temporary pullbacks is elevated, but returns could well remain healthy, in our view.  The average return for the year following low volatility years is about 5%. The average return for years following those when the market set multiple new record highs is over 7%.  The macroeconomic conditions which drive the market do not change because we turn the page on the calendar and put a new digit on the year.

    While it’s hardly a bold call to say that 2018 is going to be a more challenging year than near perfect 2017, we do not believe the U.S. is nearing bear market territory. Recessions and bear markets tend to go hand in hand, and right now, recession indicators are not flashing red. U.S. economic data continues to be bullish for market returns. The new orders component of the ISM manufacturing index rose to 64 in November, while the inventory component sank to 47. Historically, a wide gap between the two is a powerful predictor of positive stock market returns. The current gap is wider than it’s been 87% of the time historically. Core durable goods orders, initial unemployment claims, capex intentions, consumer and business confidence, global PMIs, and other leading indicators also paint an upbeat picture.

    History suggests the 7th and 8th innings of a business cycle expansion are often the most profitable for equity markets. Since inception, the S&P 500 has delivered an average annualized total return of 14.2% in the 13 to 24 months preceding U.S. recessions, well above its 10.1% annualized average during full business cycle expansions. The S&P 500 did even better in the 7 to 12 months prior to the beginning of the last three recessions, generating annualized total returns of 22.2%, 20.0%, and 13.6% leading up to the recessions of 1990-1991, 2001 and 2007–2009, respectively.

    Bottom line: With recession likely a year or more away, the probability of rewarding equity market returns is high.

    Globally, the picture is even brighter. The MSCI All Country World Index generated a total return of 24.6% in U.S. dollar terms in 2017, beating the S&P 500 by almost three percentage points. For the first time in more than a decade, global economic growth is widespread. Almost 75% of developed economies are at full employment, and most global macroeconomic indicators are pointing to strong growth. The Global PMI is broader than it’s been in a decade, and its manufacturing component is at its highest level since early 2011.

    Notably, the global manufacturing PMI has peaked a median 15 months before the beginning of global recessions, while the global OECD Composite Leading Indicator has peaked a median seven months before recessions. At this point, there is little indication that either of these indicators has reached its high point in this cycle. Taken together, they suggest that the current global expansion has longer to run than the U.S expansion, which began much earlier and is likely further along.

    Even regions plagued with long-term structural problems are experiencing a cyclical bounce. For example, the Japanese and European economies are seeing some of their best growth in years, and policymakers are taking advantage of this strength to address difficult issues. In France, President Macron is implementing many of the labor reforms that were successful in Spain. France’s production outlook is at its highest level in 17 years.

    In Japan, Prime Minister Abe’s economic restructuring efforts are finally bearing fruit. The decline in the labor force due to Japan’s aging population has recently been mitigated by rising female labor force participation and an increase in foreign guest workers. The female labor force participation rate in Japan for women aged 15-64 is now 70% and foreign guest workers have increased from 720,000 in 2013 to an estimated 1.3 million last year.

    Importantly, corporate profit margins in Japan are now at a 70-year high. This is significant because Japanese companies traditionally put a higher priority on sales growth than profitability. We think this augurs well for Japanese stocks.

    Our bullishness on Japan makes us somewhat unusual. In Barron’s October 2017 money manager survey, only 6% of managers expected Japan to outperform other regions over the next 12 months. This compares to 45% of respondents who chose emerging markets to outperform, 29% who chose Europe, 13% who chose the U.S., and 7% picking China. We believe most managers are underappreciating investment opportunities in Japan. We like being early and think the
    risk/reward trade-off is now favorable for Japan. Most of all, we like the fact that many companies in Japan fit squarely in our themes.


    What We Worry About

    Change tends to occur more slowly when inflation is low, but inevitably, market dynamics do shift in response to economic and societal developments. We are on guard for economic distress signals. As Charles Darwin famously said, “It is not the strongest of species that survives, nor the most intelligent, but the ones most responsive to change.”
    In the U.S., year-over-year earnings comparisons are becoming more challenging, and the recently passed tax cuts may overstimulate the U.S. economy, and thus hasten the end of the business cycle. The tax bill represents incremental stimulus to an already strong economy. Unemployment today is just 4%, versus its 7% average when the last seven major tax cuts were enacted. No major U.S. tax reduction has been enacted when the unemployment rate was this low. If too much stimulus leads to higher levels of inflation, the Federal Reserve could boost interest rates faster than expected, choking off economic growth.

    We are also concerned about geopolitical risks, including North Korea, rising tensions in the Middle East, impending elections in Italy and the consequences of Brexit, as it proceeds. A trade war or an unexpected exit from NAFTA would almost certainly have a negative impact on equity markets.

    In sum, there is no shortage of reasons to worry. We will monitor these situations and others that will almost assuredly arise.  As the facts change, we will react and reposition accordingly. The positive side of our 2018 outlook is that the secular bull market is well intact and should continue. The negative side is that the year is likely to include increased volatility and abrupt market corrections.


    Only a Few Stocks Matter

    As relatively concentrated thematic investors, we have never tried to know everything about every company or even every sub-industry in the market. Instead, we focus on what we believe are the most fruitful areas for investment, those tied to our themes.
    Each of our themes made a positive contribution to portfolio performance in 2017 and over the past three years, but in each year, different themes have been the biggest contributor. In addition, in each year, a handful of stocks drove a disproportionate share of portfolio returns. Researching and picking these “winners“  is central to our thematic investment process.

    According to the economist Hendrik Bessembinder, the net gain in the U.S. stock market since 1926 is attributable to the best-performing 4% of listed stocks; the other 96% percent collectively matched the return of one month Treasury bills. Bessembinder expressed these gains in terms of “lifetime dollar wealth creation,” the contribution to the equity market’s net gain from each stock, starting in 1926 or when the company first appeared in the database through the end of the measurement period or earlier delisting of the stock.

    Some market experts use this analysis to tout the virtues of passive investing, claiming it is impossible for active managers to consistently find high-performing stocks. We disagree. We believe thematic investing is more likely to succeed than other active investment approaches because it focuses on companies that are disrupting the status quo and are well positioned to capitalize on structural and economic change. In financial terminology, thematic investing seeks to find investments with positive skewness: greater upside potential than downside risk. Our thematic research is dedicated to identifying these opportunities.


    Portfolio Positioning

    Global markets, generally, have performed well, and many regions still look promising. We are continuing to increase non-U.S. developed market exposure in portfolios. As noted above, we think there are compelling thematic opportunities in Japan and Europe, in particular.

    Our thematic research has recently led us to a new focus area related to curation-influenced opportunities in consumer spending. Curation uses a combination of online data and offline expertise to winnow down the choices presented to shoppers. For many consumers, the proliferation of online stores, travel sites, media and entertainment offerings and other online outlets is overwhelming. Too many choices can sometimes lead to less spending. Technology and consumer companies are teaming up to help vendors customize offerings to specific consumer preferences and then help users navigate the vast array of options.

    This avenue of research stemmed from our work on the growing importance of intangible assets. Data is quickly becoming one of the most prolific commodities in the world, and if used intelligently, one of the most important assets a company can own. Retail and media firms, as well as other consumer-focused companies, are cataloging our online purchases, the length of time we spend on each page of their websites and how we click from one item to the next. However, their ability to monetize this information effectively varies greatly.

    Some companies are extremely good at using data. For example, Amazon has said that it had recommended roughly 70% of the items purchased on its site, based on either other consumers’ purchases or the shopper’s own purchasing history. Similarly, some 90% of shows watched on Netflix were Netflix-recommended. Many other companies don’t yet have the expertise to translate information into higher revenues.  We think this will change. Our research suggests that e-commerce is still in the early stages of improved curation, a trend that may eventually enable smaller companies to compete with industry behemoths.


    Fixed Income

    The 10 year U.S. Treasury bond ended 2017 with a yield of 2.41%. This is only 4 basis points (0.04%) lower than the 2.45% level when the year began. Volatility in the bond market, like the equity market, was very low. The 10-year yield reached a high of 2.63% on March 13, 2017 and a low of 2.04% on September 7, 2017.

    The shape of the yield curve flattened rather dramatically throughout the year with the short end of the curve rising by approximately 75 basis points (0.75%) despite the long end remaining virtually unchanged. The yield curve is currently at its flattest level in 10 years.

    The increase in government debt resulting from the recent tax bill is likely to raise equilibrium bond yields modestly. The Fed estimates that the equilibrium 10-year bond yield would rise on a structural basis by 3-4 basis points for each percentage point increase in the Federal government’s debt-to-GDP ratio, and by 25 basis points for every percentage point increase in the deficit-to-GDP ratio.

    Bears have been calling for the end of the 30+ year bull market in bonds for several years now, and once again many fixed income forecasters are projecting significantly higher yields in 2018. We are not convinced that the end is nigh. However, by investing in individual bonds rather than mutual funds or bond ETFs, we dramatically reduce our risk if significantly higher yields do materialize.


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