Q3 2019 - Will FED Cuts be Enough to Fight the Global Cold? 

 

Commentary by the Trust Investment Committee 

 

Despite the yield curve frenzy, escalating trade tensions and Washington rhetoric the third quarter came and went without much to be disappointed about. The major U.S. indices remain resilient and are only a couple percent from record highs set in July. The S&P 500 returned +1.68% for the quarter and is higher by +20.55% YTD, however, we have to be mindful that the S&P 500 is essentially flat year over year when factoring in the fourth quarter of 2018. The technology heavy NASDAQ enjoyed a quarterly gain of +0.17% and is higher by +21.46% YTD. On the economic front, employment data released for the quarter was good enough to keep the unemployment rate below 4% and wage growth at reasonable levels, however, the job market is showing early signs of plateauing.  Longer-term trends and rolling averages are off their 2018 pace. With subdued inflationary pressures, the Federal Reserve can afford to remain accommodative in order to sustain the longest U.S. economic expansion. The U.S. economy is beginning to show signs of slowing, but with a second quarter GDP reading of 2.0%, the economy remains sound. As we write, third quarter earnings season begins next week with analysts forecasting a year over year decline of 3.7% Earnings expectations are at the lowest they have been in years and guidance will be paramount as investors have been stricken with uncertainty surrounding the tariff fight and the state of corporate America.

 

Trade tension between the world's two largest economies remains elevated as there has been little progression throughout the year and the parties remain distant on key issues regarding policy enforcement and intellectual property. Currently, the U.S. has imposed tariffs on $550 billion worth of Chinese products and China retaliated by imposing tariffs on $185 billion worth of U.S. goods. As a goodwill gesture, our administration has delayed increasing the tariff rate to 30% on $250 billion worth of Chinese consumer goods since the enforcement date coincided with the 70th anniversary of the People's Republic of China. China was receptive to this delay by announcing they would exclude additional tariffs on U.S. soybeans and pork. With high-level talks set to resume in mid-October we believe that a deal will eventually be accomplished, however, trade policy uncertainty continues to weigh on a slowing global economy.

 

At the September Federal Open Market Committee meeting, the Federal Reserve cut the Fed Funds Rate for a second time this year by another 25 bps (basis points) bringing the Fed Funds range to 1.75% - 2.00%. Chairman Powell refused to provide any details on the future path of rates and stated that they will remain data dependent. With the technical inversion in the yield curve that occurred during the quarter, the market is anticipating that the Federal Reserve will cut the Fed Funds Rate one last time in 2019.

 

Equity markets continue to paint a rosy picture; however, the bond market was afflicted by recessionary fears when the yield curve inverted for the first time since 2007. Historically, a recession has occurred on average twenty-two months following an inversion which speaks to the sensitivity of this topic. The 10-year treasury ended the quarter at 1.67%, declining 102 basis points, or -1.02% lower, since 12/31/2018.  The yield curve is no longer inverted but remains uncomfortably flat with the two and 10-year yield difference at about 4 basis points. Both foreign and domestic bonds are experiencing equity like returns this year, as the Barclays Aggregate Bond Index is higher by +8.52% YTD. 

 

Central banks across the globe have been briskly cutting interest rates and launching additional stimulus measures to help reignite global growth. The ECB President Mario Draghi announced that the central bank will cut its deposit rate further into negative territory; as well as, a new quantitative easing program. With over $15 trillion worth of negative-yielding government debt worldwide, monetary policy is breaching its limitations of effectiveness and the eurozone will need to eventually embrace fiscal stimulus. Due to global trade disputes and slowing economies, the international markets continue to underperform the U.S. The MSCI EAFE Index closed the quarter down -1.07% but is higher by +12.80% YTD. Emerging Markets ended the quarter -4.25% and are up +5.90% YTD.

 

THOUGHTS ON ASSET ALLOCATION

 

Our Trust Investment Committee remains comfortable with our current allocations in equity and fixed income. The next several Investment Committee meetings will contain thorough discussions on 2020 positioning. We cannot emphasize enough that our clients continue to remain focused on their long-term financial goals. As the economic cycle ages gracefully, our portfolio allocations continue to have a slight emphasis on value over growth as we are cognizant of the risks and elevated valuations present in certain pockets of the market. 

 

Regardless of the market conditions, we are confident that our best-in-breed managers can weather the tough market environments and protect capital in times of turbulence and geopolitical distress. Listed below is a subset of our equity and fixed income managers that performed exceptionally well in a market that preferred lower quality and momentum.

 

Investment Manager                               * Q3 2019 Return                        Manager Benchmark

 

Federated Strategic Value Dividend                 +4.19%                             +3.58% Dow Jones US Select Div

 

Alta Capital Large Cap Quality Growth           +3.88%                             +1.70% S&P 500 

 

PIMCO Investment Grade Bond                       +2.97%                             +1.37% Barclays Intm Gov/Cred

 

Blackrock High Yield Bond                               +1.93%                             +1.33% Barclays US Corp HY

 

Dana Investment Advisors Large Cap             +3.74%                              +1.70% S&P 500

 

*Returns are from actual portfolio results. Results may vary. Past performance is no guarantee of future returns

We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214