Our Insights

Staying invested in securities of quality companies that serve the world’s needs is the key to harnessing compound savings, growth and income. But, as experienced in the fourth quarter of 2018, it can sometimes be a rough ride, often influenced by irrational emotional swings. The best tool for smoothing out that journey (and mitigating loss) is having the patience and discipline to stick with an asset allocation plan – investing in different asset classes (types of securities) and broad diversification. Investments that consistently provide a stable income stream also help getting through the inevitable market downdrafts.

 

Following the fourth quarter of 2018, the U.S. equity market was trading at 16 times expected earnings – historically reasonable, given the low inflation and interest rate environment. International and emerging market stocks were even cheaper. The big December sell-off was emotional – disconnected with strong economic fundamentals. We thus took the opportunity to increase exposure to stocks and high yield fixed income, and reduced inflation protected bonds (while maintaining the asset allocation balance). Markets and more importantly, client portfolios have bounced back significantly since year end.

 

Recently, the Fed has announced that it will stop raising interest rates and curtail the slow $50 billion per month reduction in the Fed’s balance sheet (the so-called QT, or quantitative tightening program) by the end this year. In a 180-degree turnabout, the Fed also warned that it could bring back QE, or quantitative easing and maybe even an interest rate cut to deflect weakening global economies (possibly the result of the falloff in global trade and rising tariffs).

 

Now that (U.S. stocks in particular) have re-gained lost ground, now approaching the January 2018 highs, global markets need a positive catalyst to maintain current levels and momentum going forward. The most immediate catalyst would be a favorable (and legitimate) trade deal between the U.S and China with tariffs and threats of more tariffs fading away. In many ways – to maintain its command and control, autocratic economic system (while keeping a billion plus increasingly informed consumers at least somewhat mollified), China needs a good trade deal more than the U.S.

If a reasonable China trade deal can be accomplished and first quarter corporate earnings and expectations don’t get ratcheted down, we could see higher equity prices (particularly so with the lower priced international and emerging market stocks). That said, be prepared for a pullback, after that significant first quarter run.

What about the longer-term view? The economy is growing at a real rate of 3.1%, but the U.S. budget deficit for 2019 is $1.1 trillion (a deficit level one would expect in times of recession). Over many years, annual deficits have been piling up to a total national debt of over $22 trillion. Entitlements and mandatory spending (two thirds of the budget) and are rising rapidly.

Deficits and debt have been largely ignored because of MMT (Modern Monetary Theory), suggesting that governments can expand (money creation) and contract the money supply at will to meet spending and at the same time control inflation. However, at some point there will be fewer buyers of government bonds (keeping in mind that China has been a major buyer), putting downward pressure on the dollar.

A weak dollar bodes well for ‘real’ assets – natural resources, real estate, land, commodities, precious metals and energy. International and emerging market stocks also do well in times of dollar weakness. Thus, it remains important to maintain asset allocation discipline, with exposure to these under-valued areas while maintaining good quality and income production.