Client Letter 2018 Q3

2018 Vacation

As we do each year, we want to advise all Portfolio Management clients about our upcoming vacation plans. This is a special year for Sandra and me as we celebrate our 20th wedding anniversary and have planned our vacation for two weeks instead of our normal one week. We will be out of the office from Friday, August 17 to Monday, September 3, 2018. We will be back in the office on Tuesday, September 4. During this time, we will have limited access to phone and email, but if you need us please call the office number and leave a message with John or on voicemail. We will do our best to respond in a timely manner. You can also call Fidelity with account related questions at 800-544-6666.

Q2-2018 Market Results

The markets were a mixed bag in the second quarter of 2018. Once again, the U.S., as represented by the S&P 500 index, took the lead witha total return +3.43% for the quarter. Other markets didn’t fare as well. International markets were down -1.07% and emerging markets were hit hard at -7.83% for the quarter. Global ex-U.S., a good indicator of world market activity outside of the U.S., was down -2.47%. The U.S. bond market was stable at -0.16%. Short-term treasuries were also up this quarter at +0.43%. This could indicate that some market participants are willing to forego the potential returns of riskier investments in favor of less risky short-term U.S. treasuries.

Portfolio Thoughts

Tactical portfolios did well in the second quarter, mostly attributable to their diversification and added U.S. exposure. U.S. investments had a better quarter than international investments. I had over-weighted international investments a few months back, but I will be adjusting to a more neutral allocation. I will continue my overweight in the emerging markets because I don’t think what happened last quarter is justifiable given their economic fundamentals. Momentum portfolios shifted in early June from global investments into U.S. investments. Because of the way momentum works, there is a delay in how the markets are moving and when the model shifts its recommendation. U.S. investments outperformed global investments in the first two months of the quarter, but the model didn’t change until the third month. This delay is normal. Momentum has to change and indicate a new trend for the model to adjust. The bond market is adjusting to the rising interest rates, but I am glad that I have underweighted exposure to core bonds in favor of more strategic bond choices.

Q2-2018 Notes

The Federal Reserve (Fed) raised the federal funds rate again in June by 0.25%, setting it now at 2.0%. This rate reflects the continued strength of the U.S. economy and the progress made since the 2008 global financial crisis. Politically, not a lot happened in the second quarter, though one could argue that the announced retirement of Supreme Court Justice Anthony Kennedy has potentially significant political fallout. Most of the political noise stems from the upcoming mid-term elections in November. Democrats are trying to take control of the House of Representatives, and (at least) improve their minority status in the Senate, while Republicans are taking equally aggressive steps to prevent the same. Normal dynamics for a mid-term vote.

My thinking is that this past quarter was greatly impacted by geopolitical forces around the world. In the U.S., the economy is strong, unemployment is historically low, and corporate earnings have grown to
record levels. These are all positive drivers of market performance. On top of that, the U.S. President met with the leader of North Korea and started a dialogue that might reduce the risk of another war in Korea. I believe this also helped U.S. markets. Internationally, the economy in Europe has generally been positive, and unemployment has improved. But, the political developments in Europe pushed markets in the negative direction. Germany’s prime minister, Angela Merkel, is facing real problems with her government and its response to immigration issues. And right-wind, anti-immigration parties have gained favor in Germany. Italy now has a populist government that is anti-European Union (EU). Spain has elected a pro-EU leader, who is also a socialist. Both are expected to push against standard EU policy. The economies of Italy and Spain are large enough, and the expected policies concerning enough, to push markets down. Emerging markets got hit the worst last quarter, even though their economies are showing strength. I suspect the big issue here is the concern of a trade war with the U.S. and how that might affect emerging economies. The recent strengthening of the U.S. dollar (also attached to trade policies) also negatively affects emerging markets.

The summit meeting between Donald Trump and North Korean leader Kim Jong-un was a significant historical event. Not because of the deal struck or commitments made, which most consider little more than a starting point, but because only a year ago there was serious concern over a second U.S. war in Korea. Kim Jong-un was overly belligerent with a president that seems to have a thin skin, and that combination seemed headed for a bad ending. Having a summit meeting doesn’t mean we won’t get back to that condition, but it does mean there is at least some mutual interest in finding another path. What I find most interesting about the meeting is how it plays into other geopolitical events, and rarely does the main stream media mention, or discuss, these connections. For instance, China is very interested in how North Korea deals with the U.S. China wants to reduce or eliminate the U.S. military presence from South Korea, and it wants to reduce or eliminate the North Korean nuclear threat, but it does not want reunification of the Korean peninsula. So, it wants North Korea to go only so far in its willingness to shift its policies. Now, as Donald Trump considers the Chinese motives and tactics, is it possible that the “trade war” that is allegedly being waged is part of a negotiation strategy to help the U.S. achieve its own goals in Korea? Are these same techniques also being used in the trade negotiations taking place with South Korea and Japan, who have their own desired outcomes for any agreements struck by the U.S. and North Korea. I believe that there are numerous moving pieces as part of this process, and that also helps explain the slow pace at which the negotiation is moving. When there are that many moving parts, the process slows greatly. Also, on the issue of timing, how much of the negotiation process and timing is designed to improve the chances of reporting a positive North Korean negotiation result shortly before the November election? Politics and diplomacy often go hand-in-hand.

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.