Broker Check

Quarterly Client Letter

January 08, 2019

WELCOME TO 2019! Another year is in the books and oh what a difference a few months makes. It was “Puppies & Rainbows” coming out of the summer to “Blood in the Streets” by year end. Regardless of what lame references we use to describe the economic climate, the last 3 months have been a reminder that risk happens slowly and then…all at once.

This phrase captures the essence of what transpired in the final quarter of 2018 as the S&P 500 posted its worst December performance since 1931 with a fall of more than 9%.[1] The rapid decline in the U.S. equity benchmark last month capped what ended up being an annual decline of greater than 6% while a broader gauge of publicly traded American companies (Russell 2000) finished 2018 down roughly 12%.1 Stock markets outside our borders also struggled despite some signs of stabilization towards year-end as the Europe Stoxx 600, MSCI Asia Pacific Index and the MSCI Emerging Market Index each slid at least 13% over the course of the calendar year.1

It is relevant to note that coming into the 4th quarter, the S&P 500 had just completed its best 3 month performance in nearly 5 years.1 Just as many were becoming overly excited with so called “F.O.M.O” emotions (Fear of Missing Out), we remained strongly focused on our process which is above all else defined by risk management. We emphasized the following in our last quarterly letter on October 1st: “Our analysis indicates that both the U.S. economy and stock market are unlikely to sustain last quarter’s large positive performance unless the global backdrop improves. With much of the world slowing down economically and a large portion of the benefits of domestic fiscal stimulus in the rear view mirror, we have adopted a slightly defensive posture within our U.S. equity allocation.”

Ultimately the market dynamic turned abruptly negative and we became even more defensive as the 4th quarter progressed. We reiterate that this was by no means a reflection of any ability to consistently predict the future.
(FYI- This is impossible regardless of what many claim.) Instead, we see this as symbolic of our commitment to maintaining a process driven approach to investing at all times. Having buffered portfolios from a great deal of the carnage experienced last quarter, we are now able to sail smoothly into 2019 in search of opportunities.

Below are a few points on several economic themes we’re seeing around the globe:

Monetary tightening was a major theme in 2018 as the U.S. Federal Reserve continued raising interest rates and various global central banks reduced stimulus. The prospect of sustained trade tariffs weighed heavily on business sentiment in China as did the ongoing attempt by policy makers in Beijing to decrease extreme levels of debt in the country’s banking system. In the New Year, we will be closely watching for evidence of pauses to monetary tightening (or perhaps reverses) in any of the major economies. This prevailing dynamic will likely have a profound impact on currencies, commodities, bonds and stocks.
Valuations in equities around the world are now notably cheaper as compared to the vast majority of last year. Furthermore, a lack of strength in the US Dollar could provide a boost to the earnings of domestic multi-nationals and help unlock relative value in several international stock markets. The recent collapse in WTI Crude Oil prices should help boost global economic growth although a further rapid decline may cause additional panic surrounding the outlook for economic demand. Similar to the 2014 through early 2016 time period, we think the oil market has once again taken center stage as a primary input for both asset allocation and risk management.
The U.S. aggregate bond market declined for much of last year due to rising interest rates before benefiting from a flight to safety late in the year during the sharp selloff in stocks. Corporate bonds did especially bad in 2018 as relatively risky types of credit tracked stocks lower and did not provide the benefits of diversification. We have been warning of credit risk for some time and we remain focused on quality and liquidity within our fixed income positions.
One of the hardest things to do in this investment management & financial planning world is simultaneously preparing clients’ portfolios for near-term risks while also keeping an eye down the road for opportunities. It’s also VERY difficult to convince anybody that they should be satisfied with losing money over a given quarter. But ultimately, that’s the price of admission to long-term investing in capitalism. While it is understandable that sometimes your emotions tell you to scream at the TV…your advisor…your dog and bury your money in the backyard; our belief is that if we can preserve value now, we’ll have more to grow when things turn around down the road.

As uncertain times could persist, we ask everyone to remain confident in our commitment to the on-going risk management process. As is our norm, we are always available for any questions or concerns that may arise.


[1] Source: Bloomberg