Client Letter 2018 Q4

Q3-2018 Market Results

In the third quarter of 2018 the U.S., as represented by the S&P 500 index, had another impressive showing of +7.71%. This builds on generally decent Q1 and Q2 returns for a YTD return of 10.56%. Global ex-U.S. investments didn’t fare as well at +0.70% for the quarter and -3.09% for the year. Breaking down further, developed international markets were up +1.35% for the quarter and -1.43% YTD. Emerging markets were disappointing at -1.10% for the quarter and -7.68% YTD. The U.S. bond market was up very slightly at +0.02% but down -1.60% YTD. Short-term treasuries were once again up at +0.49% for the quarter and +1.28% YTD.

Portfolio Thoughts

All portfolios had gains in the third quarter, due to strong gains from the U.S. and mild gains in International. Tactical portfolios maintained an underweight to International given the challenges that region has been experiencing. Emerging markets

reduced portfolio performance, particularly in more aggressive Tactical portfolios. However, I remain overweight Emerging markets as I believe their fundamentals are too strong to continue underperforming. I may change that view as data continues to come in. Momentum (a.k.a. AAA) portfolios did extremely well in the third quarter as the model’s equity exposure was fully in the U.S. The momentum model remains positive for the U.S. and I will maintain this position until the model changes. Bonds were flat to slightly positive within most portfolios. Tactical portfolios utilize a good amount of bond diversification that can help returns. I’m finding bonds to be one of the more challenging portfolio management components in the current environment. With interest rates rising since 2016, and continuing to rise, bonds have lost some value. That has been the case for all of 2018, and I expect most if not all of 2019. Bond markets are having some difficulty adjusting to the ongoing rate increases, and expectations of future increases, making bond investment choices difficult. Keep in mind that while bond values may decline, those same bonds can produce annual yield income of 2% or more, which in my opinion remains a better option than committing those assets to cash.

Q3-2018 Notes

Speaking of bonds, the Federal Reserve (Fed) raised the federal funds again in September by 0.25%, setting it now at 2.25%. As I’ve said in the past, rate increases in this economy makes sense to me and I believe we continue our path toward normal monetary policy. With U.S. Gross Domestic Product (GDP) coming in at 4.2% in the second quarter, having a federal funds rate at 2.25% is nowhere near tight monetary policy. Good policy in my opinion.

The third quarter was dominated by two political movements. The first is the coming mid-term elections and the normal political campaigning and rhetoric that elections generate. The second is the situation with Supreme Court nominee Brett Kavanaugh. This story has absolutely dominated the media for the last several weeks. More than the elections, and more than the ongoing Trump/Russia investigation with Robert Mueller. The Kavanaugh nomination has become an extremely controversial and emotional topic. Personally, I’m most impacted by what I perceive as terrible behavior from both of our political parties. One of the worst examples of political dysfunction I’ve seen.

Globally, reactions continue to the trade rhetoric coming from President Donald Trump. I purposely did not refer to trade policy because much of what President Trump says has not, and may never become,
actual policy. It seems his Presidential style may be a copy of his construction-mogul style of strong language and bully-like tactics. Whether this will get him the results he wants is still unknown. My view is that we are not in the alleged trade war so often mentioned in the main stream media. I think, given the limited formal policy impact, it’s more like a trade “skirmish”. The truth is that other countries have tariffs on imported goods, as a way to protect their own, local producers. But, those same countries often want unlimited export access to the world’s largest consumer market…the U.S. One country has come to symbolize this unfair trade mentality, that being China. To illustrate, the World Economic Forum ranks the U.S. as #22 on its “trade openness” list while China ranks #61 out of 136 countries listed. President Trump has focused much of his trade rhetoric, and some degree of policy, on China. U.S. trade policy with China dates back to when the country was in its early modern development stages and the U.S. encouraged its economic progress with one-sided open trade. Not to mention the U.S. hoped that helping China build a strong economy might lead them to reject their communist system. Now, forty years since these policies evolved, China has built a very strong economy, which is mostly closed to U.S. exports, and they are even more fully embraced in communism. Given this reality, and the overwhelming onesided bias to the U.S./China trade situation, I believe it is time to reconsider our 40-year old trade policies. However, I have no way of knowing if President Trump’s methodology will provide results. So far, what I’ve seen of the new deals with Mexico and Canada, plus the improved trade talks with the European Union (EU) appear encouraging. Trade wars are bad, but the occasional trade skirmish might prove beneficial.

Continuing this China theme, I’d like to talk a bit more about this complicated country. China has become the world’s second largest economy, built mostly on a mercantile strategy of low-cost labor and inexpensive exports. However, China’s aspirations are much more than economic. Publicly, they have two important policies the U.S. and other nations must consider in their national security. The first is “Made in China 2025”. This policy is aimed at finding ways for China to become the leading developer and supplier of hi-tech products such as semiconductors, robotics, aerospace and artificial intelligence. The policy may promote behaviors that result in the intellectual property theft accusations of which we often hear. The second policy is less formal, but no less important. It is Chinese President Xi Jinping’s Vision 2050. This vision illustrates, and been openly verbalized, that China will become the leading global superpower by 2050. If you’re a government official in a non-communist country, thinking of the future of the world, do you want any chance of China becoming the global superpower? If not, it might be time to start thinking about containment. Xi Jinping has been in power since 2012 and has driven much of his county’s policy focus. That is why we’re just now seeing so much attention, push-back, and containment strategies from the U.S. and other countries. This containment, I believe, is part of the trade skirmish discussed above.

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,


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.