Client Letter 2020 Q1

Q-4 2019 Market Results

The fourth quarter of 2019, and the full year of 2019 were good for the markets, especially the U.S. The U.S. S&P 500 index was up +9.07 for the quarter and +31.49% for the year. The international market index was up +8.17% for the quarter and up +22.01% for the year. The emerging markets index was up +11.84% for the quarter and +18.44% for the year. Bonds also held up for the quarter with the U.S. aggregate bond index at +0.18% and +8.72% for the year. Short-term treasuries were somewhat less exciting, but still positive at +0.51% for the quarter and +3.60% for the year.

While the one-year returns look impressive, it is important to remember the context of what happened in late 2018. Starting in early October 2018, global stock markets went into a freefall. At one point in late December, the S&P 500 was down over -20%. So, part of the impressive 2019 return is the fact that markets had to recover close to 20% just to get back to where we were at the end of September 2018. Returns from the end of September last year to end of 2019 look a bit more realistic at +13.71% for the U.S., +6.72% for international and +9.58% for emerging markets. For this past quarter, markets were higher most of the time with the exception of a small pullback in both early October and early December. Both of those pullbacks were short lived. Overall, a good quarter and a good year.

Portfolio Thoughts

The fourth quarter, and the entire year, were solid for most investors. Tactical portfolios benefited from strong results in the U.S. and got at least some help from the international markets. Momentum portfolios did very well as the model continues to point to investing in the U.S., which has been by far the strongest market. Strategic portfolios also did well due to some help from international markets, plus effective rebalancing and low fund expenses. Bonds had an OK quarter but finished the year quite strong. As I mentioned last quarter, the good bond results help more conservative portfolios with higher levels of fixed income exposure. For the first quarter of 2020, I will be adding exposure to emerging markets, reducing exposure to hi-yield bonds and adding some additional fixed income diversification by adding a position in mortgage backed securities. We will remain overweight U.S. exposure and out of inflation-protected bonds. Real estate will remain the sole alternative investment choice

Q-4 2019 Notes

The Federal Reserve (Fed) lowered rates again in October after reductions in July and September. The current reserve rate is now in a range from 1.50% to 1.75%. The most recent Fed language is indicating that they will not lower rates again unless something more significant changes in the economic data. My feeling is that these reductions were done to prevent over-reaction to the ongoing stories of the global trade war, possible Presidential impeachment and deepening tensions with Iran and North Korea. At least some of those potential concerns have been addressed, so further reductions seem unnecessary for now. If the economy continues to expand, I think it is possible we will see rate increases as we get further into 2020. While it is true that global growth was slowing during 2019 it appears to me that we will see a moderate resurgence of growth in 2020. Recession odds in my view for the next year are 25% or less. This long expansion looks like it will continue for a while longer. Employment is strong, consumer spending is strong, wages are moving higher, corporate profits are good and the Federal Reserve has provided plenty of monetary easing. The story remains in place for stock markets to at least hold ground, if not move higher going forward.

Politically, the U.S. has experienced the third Presidential impeachment in its history. Though, some argue that impeachment is not official until the terms have been sent to the Senate. I am aware of, and sensitive to, the strong opinions about this topic. Let me simply say that from the behavior or our President, to the behavior of our Congressional Representatives, I think this is far from our brightest moment in history. I expect those terms will be sent to the Senate and we will see that trial develop sometime in January. I’m not at all looking forward to the drama.

Last quarter I went into a detailed explanation of my views on the alleged global trade war. Before I continue on the points I laid out last quarter, I want to illustrate my reasoning for referring to this as the “alleged” global trade war. Some in the media use the trade war terminology frequently and have suggested our current trade path could be likened to the Smoot-Hawley tariff legislation passed in 1930 (that legislation, and its aftermath, is generally considered a significant contributor to the Great Depression). But the evidence doesn’t support this view. In the two years after Smoot-Hawley passed, U.S. imports dropped 70% and exports dropped 69%. That truly was a trade war. In contrast, trade with the U.S., both imports are exports, rose in 2016, 2017, 2018 and continue to rise. While it is true the U.S. is working to revamp the global trade model, I do not agree that the U.S. has instigated a global trade war.

Getting back to my previous points on trade, last quarter I suggested the U.S. created a purposely lopsided trade model with most of the world as a way to help those countries rebuild after WWII, assist developing countries and build alliances that would resist communism. At the time these were entirely reasonable choices and the volume of goods the world sold to the U.S. was low enough that it did not impact the U.S. in a significantly negative way. Additionally, important alliances did form to resist communism and help the U.S. win the cold war. Fast forward 50+ years and the Soviet Union has collapsed, global exporters are sending huge volumes of products to the U.S., and many of those same countries have implemented trade restrictions on accepting U.S. exports to their countries. Global trade is even more lopsided than it started. This shift in trade has resulted in productivity and job losses in the U.S. at levels that are more painful and easily noticed. So, the Trump administration has put trade policy very high on its agenda. The top four U.S. trading partners, in order, are: Mexico, Canada, China and Japan. And the Trump administration has renegotiated trade deals with all four of them. I believe, given how lopsided trade policy had become, that these actions are justified. However, that doesn’t mean I fully support the actions and choices the Trump administration has made in these negotiations. Honestly, that’s above my pay grade considering my lack of deal details. I find it hard to construct a cogent argument without knowing the details. I’ve heard experts on both sides of the argument weigh-in, but much of it seems driven by partisan sentiments. I feel we won’t know how good or bad these new trade deals are for at least several years. My larger point is that the current trade arrangement is far from perfect, and changes are justified.

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.