Quarterly Client Letter – Q3 2019
- October 10, 2019
- Investment Insight
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Dear O’Brien Wealth Partners Investor,
“The more things change, the more they stay the same.”
-French novelist and critic Jean-Baptiste Alphonse Karr
Some literary scholars say that the figurative meaning of this phrase is that turbulent times do not affect reality on a deeper level other than to cement the status quo. Others more simply interpret the phrase to mean that many things remain consistent even as changes happen. The words seem à propos to the geopolitical and economic climate that has cast a pervasive shadow over global markets throughout 2019. As we enter the fourth quarter, the same uncertainties that have been haunting the market since mid-2018 – trade disputes and tariffs, slowing global growth, and central bank policy – continue to affect business and investor confidence. Business investment is slowing across the globe, magnified by negative sentiment and uncertainty around the economic outlook. Lack of resolution on trade disputes and increased tariffs are muting global growth, and consumer spending is showing signs of softening in major world economies such as China and the EU.
While geopolitical uncertainties and on-going trade tensions continue to wear on global growth, the U.S. economic expansion following the “Great Recession” of 2008 became the longest in history in July as it passed its 11th year milestone. In the U.S., none of the signs that have historically preceded recessions are flashing near-term warnings. Most past recessions have been preceded by accelerating inflation, over-heating in certain sectors of the economy (such as housing), and rapidly rising interest rates. Today, there are no obvious parts of the economy that appear over-extended, inflation remains modulated, and interest rates are near historic lows. The Fed seems committed to supporting the economy with accommodative fiscal policy, as evidenced by the rate cut made in July. Consensus is watchful but measured in predicting the timing of the next recession.
As we look at the economy, the area that we find most concerning is the decline in business sentiment. The effect of this decline is already measurable in reduced capital investment and business spending, and is beginning to manifest in manufacturing and production numbers. While unemployment numbers remain at historical lows, wage inflation has not increased, which is surprising in such a tight labor market. Unemployment numbers and jobless claims tend to be lagging indicators of recessions; however, hiring freezes tend to be more predictive in nature. We do not yet see hiring freezes reflected in economic data, but it as an area that we continue to watch.
With continuing stock market volatility, equity returns were mixed for the third quarter. Geopolitical risks that have concerned investors for the better part of the past year persist. At the same time, the U.S. economy continues to exhibit solid, if slowing, growth, with second quarter GDP of 2.3%, and historically low inflation and unemployment. In the U.S., the Russell 1000 (large cap), the Russell Mid Cap, and the Russell 2000 (small cap) returned 1.4%, .5%, and -2.4%, respectively, as investors sold small company stocks in favor of their larger counterparts. Most sectors experienced a volatile quarter, with a few exceptions. The energy sector in particular suffered from unstable oil prices, while both real estate and utilities benefitted from a lower interest rate environment.
Outside of the U.S., the MSCI EAFE and the MSCI EM, broad dollar-adjusted measures of the developed and emerging markets, were down 1.1% and 4.25%, respectively. A lack of clarity around Brexit and its impact on the Eurozone continued to drive negative sentiment in European equities, and increased trade tensions impacted countries that are export-oriented. In addition, the continued strength of the dollar magnified the negative returns from outside the U.S.
In the fixed income markets, several competing forces impacted bond returns. We saw a flight to quality into the safe-havens of U.S. Treasuries and high grade corporate bonds as stock market volatility picked up. The yield curve remained flat with an inversion in very short-term bonds propelled by the Fed’s July rate cut. Given the flatness of the curve, the rate cut did not affect long duration bonds as materially as usual. The net result was a return in the Barclay’s U.S. Aggregate Bond Index (a broad measure of the U.S. bond market) of 2.27% for the quarter. Given the volatility in the stock market, we believe that fixed income should be weighted towards providing “insurance” rather than “income” at present, and have positioned portfolios accordingly.
What does this mean for your portfolio?
We have not made any material changes in your portfolios since the end of the last quarter. We remain steadfast in our belief that stocks are your growth engine and bonds are your source of protection, and that a diversified mix of high quality investments serves you best over the long run. We have taken steps over the past two years to better diversify your stocks to weather market volatility and to position your bonds to act as insurance during a market pull back. We have added select active management through “best in class” mutual funds where we believe that stock selection can add value in both up and down markets. While we cannot predict the timing or outcome of the geopolitical uncertainties that prevail, history has shown that remaining invested in a well-constructed portfolio that is compatible with your risk profile is the single best way to meet your long run goals.
If you have any questions or would like to discuss the specifics of your portfolio, please contact your O’Brien Advisor.
Your O’Brien Wealth Partners LLC Investment Team