Client Letter 2019 Q4

Q-3 2019 Market Results

The third quarter of 2019 was not a great quarter for market returns, but it was far from bad. The U.S. S&P 500 index was up +1.70%. The international market index was down -1.07% and emerging markets were down -4.25%. Global ex-U.S. was down -1.80%. Bonds did surprisingly well with the U.S. aggregate index up +2.27% for the quarter. Short-term treasuries were somewhat less exciting at +0.59% for the quarter. I would sum it up as a somewhat “flat” quarter for global investments.

For the U.S. market, the third quarter started in July with some volatility but ended the month slightly up. The market dropped in August with some recovery near the end and ending September just slightly ahead of where we started in July. There are a variety of explanations for this market behavior ranging from concern over the alleged trade war, to U.S. political tensions and escalating talk of Presidential impeachment, to undeniably weaker global growth data being reported. The most recent rumor of trade talks with China have not substantially moved markets, suggesting that may not be the underlying reason for market behavior, or suggesting the market is ignoring the continued on-again, off-again trade talks. While I believe current political gyrations can impose short-term market effects, the idea of slowing global growth, and the mounting data of that condition is a more likely culprit.

Portfolio Thoughts

The third quarter was a mixed bag for investors. Tactical portfolios suffered somewhat from their global exposure where markets were weaker, but solid underweighting and overweighting choices helped buffer that weakness. Momentum portfolios did well because our model continues to point at the U.S. as being the most attractive market, and the results to date have confirmed the model choices. Strategic portfolios were weakest due to their consistent diversification between the U.S. and global investments. Bonds in the U.S. were up more than stocks, an unusual condition for sure. Stocks moving up while bonds also move up (i.e. interest rates down) suggests a deflationary bias for the market. Growth appears to be slowing somewhat, driving interest rates lower, raising bond prices but also encouraging stock investors to buy stocks hoping lower rates will stimulate the economy and raising stock prices along the way. For the fourth quarter, I will be adding exposure to core U.S. stocks and core U.S. bonds and reducing exposure to emerging market stocks. In an unusual move, I am removing all exposure to inflation protected bonds as I believe the current fundamentals strongly suggest lower rates moving forward and inflation seems an unlikely path for now. Real estate will remain the sole alternative investment choice.

Q-3 2019 Notes

The Federal Reserve (Fed) lowered rates in both July and September, leaving the Federal Funds rate a full 0.50% lower than at the end of last quarter. This is an interesting, if not confusing choice by the Fed. From an agreement viewpoint, legitimate concerns about global growth, trade uncertainties, and escalating tensions in the Middle East (i.e. Iran) exist. Also, foreign central banks now have about $15 trillion in negative yielding debt and the U.S. seems out-of-step by increasing interest rates. On the disagreement side, there is little evidence (since at least 2015) that interest rate policy is having a significant effect on economic behavior. Plus, lower rates provide for more limited options if/when the next recession comes. Lastly, while lower interest rates can encourage a degree of risk-taking, the evidence is mounting that more and more of those investments are increasing debt and not providing decent returns. In other words, the global economy is seeing limited growth while simultaneously experiencing dramatic debt increases. My personal sentiment is that the Fed had little choice but to lower rates. That negative yielding foreign debt has pushed the U.S. dollar higher, undoing much of any (alleged) trade gains expected from U.S. trade negotiations. My further belief that monetary fundamentals point toward lower, rather than higher, interest rates suggests the neutral interest rate sought by the Fed is lower than it has been historically.

Turning to global topics I want to spend some time on the alleged trade war. It’s an important topic and one that I feel the main-stream media is not doing a great job covering. The obvious focus has been with trade between the U.S. and China, but global trade is much broader, and a bit of history helps to understand the underlying conditions. After WWII the U.S. was the all-but clear global superpower (the Soviet Union appeared near equal but was ultimately proven not close). The Marshall Plan was launched in 1948 as a means for the U.S. to help rebuild war-torn Europe and prevent the spread of communism. The U.S. allowed outside countries easy trade agreements and became the “importer of last resort”. Foreign countries exported their products to the U.S. with limited restriction to help rebuild those foreign economies. The volume of that trade was low enough that it did not greatly hinder U.S. domestic growth. In addition, the NATO structure provided for the U.S. to militarily protect Europe and further allow them to direct their resources at rebuilding their nations rather than spending on national defense. That condition has essentially remained in place since the Marshall Plan wrapped up in 1951. Similar trade structures were put in place with Japan (Japan also enjoyed U.S. military protection) as they rebuilt their economy and then later in the 1970’s with China when they shifted to become an export power. At the time the intentions were good – easy trade helps build or rebuild foreign economies into hopeful strategic allies and provides inexpensive products for U.S. consumers to purchase. But things changed over time. Foreign countries recovered and ramped-up production and selling volumes to the U.S. that did affect U.S. domestic growth and employment. They also implemented their own trade restrictions to reduce U.S. exports to their countries in support of their own producers. Suddenly you have substantial export powers (think Japan, Germany and China) sending mountains of products to the U.S. with little or no restriction, while not allowing the U.S. to export freely back to those countries. The often-mentioned “rust belt” in the center of the U.S., a former industrial manufacturing powerhouse region, now largely abandoned, is one result of this. My point here is that global trade is not an even or fair game in any way. And the conditions that brought us to this point have changed dramatically over the years. This is not me advocating for Donald Trump’s trade initiatives, I don’t know if his administration’s approach is best and it will be years before we have enough data to make that evaluation. But I do believe the status-quo trade condition is not fair and needs to be revised. And while I believe many countries recognize the problem, restricting their exports and/or opening their imports is a big hurdle. No wonder most countries push back. [I will continue this discussion in my letter next quarter]

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.