You Can't Predict, But You Can Prepare

01 June 2019
Market Insights

Markets: US stocks are up 21.72% YTD through 9/17. Most of the growth occurred in the first 4 months of the year. The S&P 500 is only up a little over 3% since May 1st. Developed international stocks, as measured by the MSCI EAFE Index, are up 14.5% YTD. Emerging market stocks and bonds are both up just below 8% YTD. Surprisingly, bonds have been the clear winner over a trailing 12-month period with the Barclays Aggregate Bond Index up 10.08% vs. the S&P 500’s return of 5.56% over the same period.
Economy: The economy continues to provide mixed signals. Real GDP growth in the US came in at 2.0% in Q2. That was down from a reading of 3.1% in Q1. Economists project Q3 growth to come in around 1.8%, so there is clearly a flattening or downward growth trajectory. We did see an encouraging signal in August from existing home sales with Y/Y growth coming in at 1.3%. That was the first positive year-over-year reading in 17 months. On the negative side, we’ve seen many components of the DJ Transportation Average struggle, which can be a leading indicator of where the economy is headed. FedEx recently announced that the company is significantly cutting their fiscal 2020 earnings forecast, citing increased trade tensions and a weakening global economy. Europe’s economy seems to be in much worse shape than the United States. Germany’s 2nd quarter real GDP reading was slightly negative at -0.10%.
Headlines: Central bank policy and global trade tensions have continued to dominate. In the US, the Fed announced last week that they would lower the fed funds rate by 0.25% for the 2nd time in 2019 to a target range of 2.0% to 1.75%. Fed. Chairman Powell also announced that the central bank may need to begin increasing its balance sheet once again to counteract what seemed to be a few brief periods of illiquidity in the overnight bank lending markets earlier this week. The European Central Bank continues to be even more aggressive with its monetary policy than the Federal Reserve. Two weeks ago, the ECB announced that it would reinstitute its bond buying program and cut its target lending rate to -0.5%. The negative target rate in Europe has resulted in over $14T worth of negative yielding bonds. It is very difficult to imagine a positive long-term outcome for any investor who buys a bond with a negative interest rate.

Our View: Howard Marks, a well-respected hedge fund manager, wrote in his 2018 book, Mastering the Market Cycle, that you “can’t predict, but you can prepare.” We believe that quote is very meaningful in the current environment. Nobody can predict with any level of certainty as to where the economy or stock market is headed over the short run. However, we can decide to take a step back and become a little more cautious based on some of the economic and market related indicators that seem overdone or that simply don’t make sense. We’re in an environment where economic growth is leveling off and declining in some areas while debt at all levels (government, corporate and personal) continues to balloon. Five or six years ago, negative yielding bonds were practically non-existent. Now we have close to $15 trillion world-wide. The amount of assets in passive index funds eclipsed actively managed funds for the first time ever in August of this year. Some would argue that the move toward low cost index funds is a beneficial trend for investors. However, in addition to lowering investment costs, we believe it also creates the possibility for an increase in the velocity of a sell off given the concentration of assets in index funds.

As always, we appreciate the confidence that you have placed in us as your trusted advisor and we welcome your questions or comments at any time.

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Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors on the date of publication and are subject to change. The information presented does not involve the rendering of personalized investment advice and should not be construed as an offer to buy or sell, or a solicitation of any offer to buy or sell the securities discussed. All investment strategies have the potential for profit or loss.

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