March 2019

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At our Tenth Annual Investment Symposium on February 28, 2019, we presented a theme of “Distractions, Distortions & Dysfunction” and our market outlook that a) the Fed’s tightening cycle was nearly complete; b) there are parallels between current global economic conditions and the late 2015 – early 2016 period; c) geo-political uncertainties dominate the news flow; and d) various indicators confirmed “late cycle” dynamics.  At the time, the S&P 500 was continuing to recover from the sharp Fourth Quarter market correction which resulted in its first negative annual return since 2008.

It might surprise some to learn that, during the recently completed quarter, the stock market posted its best return since the market recovery began in 2009.  The indices are now slightly below the all-time highs achieved at the end of September 2018.  Perhaps the most important contributor to the market’s performance has been the reversal by the Federal Reserve.  They implemented a 180-degree turn in monetary policy, arguably switching from restrictive to accommodative without stopping to pause at neutral.  At present, the market has priced in no additional rate hikes with the next move likely to be a rate cut late in 2020.  Consequently, yields on Treasuries have fallen with the 10 year back below 2.5%.

The decline in longer term bond yields triggered investor angst on March 22, 2019 when the 10 year Treasury yielded less than the 90-day Treasury Bill.  Known as an inverted yield curve, this is a rare situation that has reliably forecasted recessions in the past.  However, there is ample research which supports the following:  a) inverted yield curves have provided false signals as well; b) the most reliable yield curve is the spread between 2 and 10 year Treasury Notes; c) historically, there has been a lag of 6 – 18 months between inversions and economic downturns; and d) the stock market has posted strong gains during these lags.  We should note that the yield on the 10 year Treasury remains slightly higher than the 2 year Treasury (i.e., positively sloped – not inverted).

With bond yields declining and equity valuations increasing, the markets appear to be disconnected.  One explanation is slowing global economic growth.  As global bond yields fall in response to weakening conditions and stimulus programs, a gravitational pull is exerted on all sovereign yields.  Accommodative monetary policy provides valuation support to equities, and greater liquidity should facilitate economic activity.  However, our Treasury market could also be forecasting slowing growth in the US economy.  Correctly interpreting and adjusting to this dynamic should prove vital to asset allocation decisions going forward.

We should not discount the fact that last year’s government shutdown distorted economic data.  As a result, investors will need a few more months to discern underlying trends.  At the same time, price stabilization in the oil market is a positive indicator.  While Germany and other European countries have recently posted worrisome data, China’s latest manufacturing gauge reached a six month high, suggesting stimulus measures there have proven effective.

With respect to geo-political uncertainties, we would characterize the ongoing political process of Britain’s separation from the European Union (known as “Brexit”) as seemingly interminable.  This suggests that all participants fear the chaos that would ensue under “No Deal” or “Hard” Brexit scenarios.  While highly incentivized to reach a mutually satisfactory outcome, the associated bureaucracies seem mired in negotiations that will likely extend well beyond our expectations.  Meanwhile, we expected the trade war with China would have been resolved during the past quarter.  Recent back and forth in the negotiations, as highlighted by various media, suggest the influence of political processes more than an impasse on economic or structural matters.  The market will likely respond favorably when an agreement is eventually finalized, but we no longer expect a resolution in the immediate term.  Given these considerations, our view remains constructive as economic fundamentals are generally favorable.  Equity valuations are no longer as attractive as during the Fourth Quarter market correction, but opportunities remain.  We remain vigilant with respect to signals emanating from the bond market.

In addition to your reports, please find enclosed a copy of our updated, annual regulatory filing known as the Form ADV, Part 2A.