- Markets rebounded sharply from their 4th Quarter 2018 swoon. A balanced equity/fixed income investor is now flat or slightly positive for the two quarters from September 1, 2018 through March 31, 2019.
- Most major asset classes and strategies posted strong 1st Q 2019 performance.
- The US survived the longest Federal government shutdown in history in January, trade negotiations with China do not appear to be getting worse, different UK constituents seem to be unable to get on the same page negotiating with the EU regarding Brexit.
Three months ago, investment headlines cried “December was the worst December since 1931.” Well, paraphrasing the adage about the weather in Ireland, wait three months and the market will likely be different. For the prototypical 60/40 portfolio, the first quarter was the best first quarter since 1991. Virtually all asset classes were positive: both US and International equities were up over +10% and both taxable and municipal fixed income were up over +2.50%. All of our alternative funds were also positive, up anywhere from +2.3% to 4.7%.
We continue to view the economy, in aggregate, as “ok”: unemployment, consumer confidence, corporate activity and bank lending all suggest moderate and sustained growth. Pressed to find worrisome signs, I would point to the level of federal deficits. They will matter when the market says they matter and I can almost guarantee it will not be at a good time. One topic where we have received questions from clients is on the US Treasury yield curve and whether its inversion is indicative of a coming recession. Our answer: perhaps, but there are good reasons to discount the inversion. First, only the 10 Year Yield vs the 3 Month yield inverted – all other standard metrics such as 10 Year yield vs 2 Year yield and 30 Year Yield vs 5 Year yield never inverted. Second, even the 10 Year vs 3 Month only inverted for a few days and is now no longer inverted. Third, as it relates to how we invest, remember that we increased the relative weight of municipal bond exposure vs taxable fixed income. The municipal yield curve is decidedly steep and far from inverted along any part of it. Finally, we would argue that the flatness of the Treasury curve is a very rational response by the market to a lack of any material inflation concerns.
It is this last point which continues to confound the Federal Reserve – their economic models would argue that with unemployment so low for so long, we should have seen more inflation. The Fed does not like it when their models are wrong. In a much-discussed speech from early March, Chairman Powell tasked the Federal Reserve with looking at alternative policy tools that could result in more favorable outcomes more often. He suggested one such tool could be to target its current 2% inflation figure over a market cycle not just every year as now, implying that the Fed may be ok if in some years inflation overshoots and runs higher than 2% if on average it centers around this 2%. Do not be surprised if we begin to hear the Fed potentially targeting Nominal GDP as well. While the introduction of these alternative tools is not imminent, and Chairman Powell himself said there would have to be “widespread societal understanding and acceptance” before doing so, any whiff of these new tools/mandates coming into reality would likely cause an immediate repricing of inflation expectations (higher) and the shape of the yield curve (steeper).
Chief Investment Officer