Client Letter 2018 Q1

Annual Charitable Contribution

As in years past, in lieu of sending Holiday gifts to clients, Barron Financial Group has made a contribution to the Northwest Connecticut Community Foundation. Similar to previous years, we pledged $25 per client household for a total contribution of $2,150. For privacy purposes, client names will not be disclosed. From Sandra, John & and me, we hope you and your families had a terrific holiday season and that this new year brings happiness, health and prosperity.

Q4-2017 Market Results

The S&P 500 followed a consistent upward trend during the fourth quarter of 2017 finishing up

+6.64% and the year at +21.83%. Global ex-U.S. stocks also had a good year at +5.00% for the quarter and +27.19% for the year. For the year, emerging market stocks were stronger than developed international at +37.28% and +25.03%, respectively. Bonds were also up for the quarter and year, with the U.S. Barclay’s aggregate index up +0.39% for the quarter and +3.54% for the year. Short-term U.S. treasuries were up +0.23% for the quarter and +0.82% for the year.

Portfolio Thoughts

The U.S. stock market was in a strong trend in Q4, for reasons I shall discuss below. Global stocks were also strong in Q4, but not quite as strong as the U.S. My momentum indicators continue to show that global stocks have greater momentum, though that may seem surprising given the quarter results. Nonetheless, my momentum portfolios still favor global stocks. My tactical portfolios are neutral to U.S. vs. global stocks based on other important factors such as valuation and geopolitical concerns. Bonds are the area where the most significant changes are being made in tactical portfolios. I think the process of interest rate increases from the Federal Reserve (Fed) will continue and inflation will, at best, slowly adjust. I’ve reduced exposure to core bonds and added exposure to emerging market debt along with a multi-sector bond, both of which I believe will better handle the continued interest rate increases.

Q4-2017 Notes

I’ve talked about tax reform in the U.S. for several quarters, particularly after the failure of the GOP healthcare reform (a.k.a. Obamacare repeal). And now, as of December 22, 2017, President Trump signed the “Tax Cuts and Jobs Act” into law. However, I think it is a misnomer to call this Act tax “reform.” For many, it does lower taxes, but the tax code remains as complicated and convoluted as ever. For me, reform implies streamlining and simplifying. Thus, I call this Act a tax cut, rather than tax reform. That said, the U.S. economy has posted better-than-average recent Gross Domestic Product (GDP) growth and the U.S. stock market has responded positively. The expectation of this new tax law may have been part of the reason for the strong market in Q4. Much of the market excitement surrounds the reduction of U.S. corporate taxes from 35% to 21%, that should result in improved corporate earnings, which logically makes those companies, and their common stock, more valuable. For those who believe in “trickle-down economics,” this change should also induce corporate investment and wage growth. Personally, I think trickle-down economics works to an extent, but is not the economic panacea some of our politicians claim it to be. The American public is generally against this new tax law, but that is consistent with most substantial government policy change. The story leading into the 2018 mid-term elections will be how the new tax law affects the economy and real people. If public opinion starts to
turn, the elections might be at least neutral for the GOP. If not, then history may repeat itself with substantial losses for the party in the White House. We shall see how it all evolves.

The Fed began reducing its balance sheet in October as promised. They also raised interest rates again by 0.25% in December, the third time in 2017. The Fed is continuing to pursue a normalization of interest rates after lowering them to near 0% during and after the 2008 Global Financial Crisis (GFC). I have generally agreed with this normalization. The Fed is forecasting three more rate hikes during 2018. Current economic growth would generally support this forecast, but there’s lots of room for drift.

From a global view, I can’t help but come back to the topic of North Korea (DPRK). I think this topic elevated to the largest foreign policy issue in 2017 and will likely remain there in 2018. To summarize the situation, North Korea has now demonstrated that they have the technology to get a ballistic missile to the U.S. mainland. Further, they have demonstrated that they have an operational nuclear explosive device. What they have not demonstrated is the ability to miniaturize the nuclear explosive for missile purposes, confirm a guidance system for target isolation, and confirm the ability to sustain atmospheric re-entry. These items represent significant technical hurdles. But, the fact that they have the most basic components in place, drives U.S. concern. Although no direct communication between the U.S. and North Korea has been confirmed, most technical experts believe these meetings have happened. And, for the most part, these alleged meetings do not appear to have made much progress, at least judging by the escalation of rhetoric. Kim Jong-un wants North Korea to be considered a legitimate, long-range nuclear threat. And he wants the respect (i.e. cessation of U.N. sanctions) he feels is deserved by achieving this capability. The reason he believes this is that of the nine countries known to have nuclear missiles, only three have documented long-range capability; the U.S., Russia, and China. North Korea is now added to that list. It is generally understood that the U.S., Russia and China recognize deploying a long-range nuclear missile would result in complete mutual destruction. North Korea’s history of deceit, broken promises and weak diplomacy make it a far-less pragmatic adversary. So, the U.S. finds itself trying to reconcile two bad options; the first, a preliminary strike to set-back or destroy the DPRK nuclear program (and perhaps kill its regime leadership) or second, understand and accept the threat and proceed to advance fortifications to dissuade any North Korean provocation. More and more, I feel we are heading for the second option. South Korea is on the front-line of retaliation and is not supportive of a strike…at least publicly. And while China and Russia have a clear interest in the DPRK continuing to be a thorn in the side of the U.S., they are unlikely to tolerate significant North Korean aggression. Thus, I still believe, once Japan and South Korea fulfill their military capability goals, and both have the financial resources to do so, we will see the DPRK once again reduced to the “who cares” status it rightly deserves. In the meantime, the verbal and written tit-for-tat will continue, without much result.

As always, I will watch and research the global economy and make investment choices to the best of my ability for each and every client portfolio. If you have questions about your portfolio, my views expressed in this letter, or anything else financial, please do not hesitate to call.

Best Regards,

Jim

Barron Financial Group, LLP is a fee-only Registered Investment Advisor regulated by the Connecticut Department of Banking.

This newsletter is for general information only and should not be considered investment advice.  Investors should consult with a trained investment professional to discuss their particular situation.