Client Letter 2019 Q1

Annual Charitable Contribution

As we have done for many years, Barron Financial Group made a contribution to the Northwest Connecticut Community Foundation in lieu of sending Holiday gifts to clients. As in previous years, we pledged $25 per client household for a total contribution of $2,375. 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.

Q4-2018 Market Results

The fourth quarter of 2018 was a rough one for markets around the world. Bad enough that for 2018 the S&P 500 had its first losing year since 2008. For the quarter the S&P 500 was down -13.52% and -4.38% for the year. International investments didn’t do any better with the Global ex-U.S. index down -11.46% for the quarter and -14.20% for the year. Emerging markets had a slightly better quarter at -7.47% but down -14.58% for the year. Unlike earlier in the year, bonds did offer some degree of buffering for the quarter with the Barclay’s bond index up +1.64% for the quarter, but only up +0.01% for the year. Shortterm treasuries also added some buffer up +0.60% for the quarter and +1.89% for the year.

Market dynamics during the quarter were particularly disturbing. In a pattern similar to what the markets did in late January 2018, an all-time market high was reached on September 20 only to be followed by a rapid decline starting a few days later on October 3. Volatility was high during the entire quarter where, out of a total of 63 trading days, 26 days had moves over 1%, 10 days over 2%, and 4 days over 3%.

My take on this market is similar to my views from late January. At that time, we hit an all-time market high followed by a rapid -11% correction. With no sign of an economic slowdown or significant geopolitical event, I felt the correction was an emotional reaction to built-in market fears. I suggested it may be some time before we see the highs reached at the end of January, but I was confident we wouldn’t remain at the lows for an extended period. Sure enough, the market experienced volatility and bounced around until April, then took until August before reclaiming those January highs, then went on to new alltime highs at the end of September. This correction, though longer and just over -16% at its worst, has a similar feel to me. We are not in a recession, nor are we close to one. In fact, corporate earnings are strong and the 2018 Holiday shopping season was one of the best in many years. Wages are up, employment is up, consumer spending is strong and with the exception of a challenging political atmosphere, the U.S. condition is enviable. This correction, from my view, is far more emotional than fundamental, to a point of being irrational. However, like you all, Sandra and I have opened our recent portfolio statements and seeing the drop is disconcerting. I understand. But it’s not wise to make changes or trades based on emotion. The rational decision is to wait for some sense of stability. It may very well be at a lower level than the September highs, but it will likely be at levels above the lows established by an irrational market. Looking ahead, my speculation is that within three to nine months we will see some market stabilization. For most investors a nine-month set-back is uncomfortable, but not existential.

Portfolio Thoughts

There was no way for portfolios to avoid losses during last quarter. Tactical portfolios were buffered to a small extent given their exposure to non-U.S. and alternative investments. I will maintain my underweighting of international, overweighting emerging markets and reducing exposure to inflation
protected bonds as I see no signs of significant inflation in the future. Momentum portfolios that included bonds also had some buffering. Bonds overall played the buffering role we hope they will. In all cases I am taking advantage of the market correction to make rebalancing trades in portfolios.

Q4-2018 Notes

The Federal Reserve (Fed) raised rates as expected in December, bringing the Federal Funds rate up to 2.50%. However, long rates are not rising as expected and inflation expectations are muted. This puts the Fed in a tough spot because they want to raise rates to avoid the economy overheating, but they have to be careful that short-term rates don’t move higher than long-term rates, a condition known as inversion. Inversion is a rare condition in the interest rate world, and one the Fed does not want to create. I don’t expect another increase in March, and likely two rate increases, at most, during 2019.

Not much to talk about politically from the fourth quarter. Yes, the election has the Democrats taking control of the House of Representatives and Republicans had a small gain to their majority in the Senate, but this was generally expected. Polls proved more reliable in this election than in 2016. The Trump/Russia/Robert Mueller investigation continued, but with less media time than we’ve seen. I think much of the country is getting bored with the story and wants a conclusion. Donald Trump has made a very unusual decision to allow a partial government shutdown, all while fully accepting the blame for it. Shutdowns have historically been bad politics for those perceived as creating them. President Trump has apparently decided that risk is worth the expected political benefit to be gained if he gets some portion of his Mexico border wall. We’ll just have to see how it all plays out.

Coverage of U.S. trade policy has continued, some of which have implied that these proposed policy choices will be bad for the country. As you may recall from my letter last quarter, I don’t see it this way. While some trade policy choices may prove to be bad, the idea that existing trade policy is good, or fair, is not true. Many countries charge tariffs on imported goods coming from the U.S., while the U.S. has one of the world’s lowest average tariff levels. That condition goes back many years to when the U.S. intentionally allowed trade imbalances to help foreign economies recover or grow. It is not surprising that representatives from other countries deride this policy direction, but what country wouldn’t want to maintain a condition where their exports to the U.S. experience low tariffs and their corresponding imports from the U.S. experience higher tariffs? I’m cautiously excited that while there will be short-term pain for all countries involved, the end result might be a better global trade arrangement.

As far as global topics, I received a number of comments regarding my views on China from last quarter’s letter. Space this quarter is limited, so I can’t get back into it, but I plan to in future letters. Stay tuned.

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.