Jul 19, 2019 2019 2nd Quarter Commentary

Market Summary

 

U.S. stocks, as measured by the S&P 500 TR Index, got off to their best start since 1997 and reached new all-time highs. During the quarter the S&P 500 gained 4.3% which included a 6.4% drop in May and then a 7% bounce in June. This year’s 18.5% first half gain came off the heels of a nearly 20% decline in late 2018, when investors worried about trade wars, slowing global growth and future path of Federal Reserve Policy.

 

While none of these concerns went away, investors were less worried during the quarter largely due to a shift in Federal Reserve (The Fed) policy. The Fed signaled that they are likely done raising interest rates and reassured investors that they were ready and willing to lower interest rates. While many investors were worried about an economic slowdown, data during the quarter suggested economic growth was positive during the quarter. Finally, a trade agreement with Mexico and a trade truce with China eased investor fears (at least temporarily) over a more serious trade war. However, at quarter end, there were still no clear signs that the trade war was over.

 

Virtually all asset classes were up during the quarter with U.S. stocks leading the way. In a continuation of recent trends, U.S. large caps stocks (specifically U.S. large cap growth stocks) outpaced non-U.S. stocks and small cap stocks. Bond prices benefited from lower yields as the Bloomberg Barclays U.S. Aggregate Bond Index returned over 3%, its highest quarterly return in over seven years. The 10-year Treasury yielded 2.00% at quarter end, down from 2.66% at the beginning of the year[1]. Below is a summary of returns for major asset classes[2].

Economic Update

 

This quarter marked the longest U.S. economic expansion in U.S. history[4]. The economic expansion has lasted 120 months and counting, surpassing the 1990’s expansion. It has also been the slowest expansion in the post-WWII era (see chart below)[5]. Although 10 years might sound old, other countries have had longer expansions. Australia hasn’t had a recession for 28 years. Also, Canada, the U.K., Spain, and Sweden all had at least 15 years of growth starting in the early 1990s and ending in 2008[6].

Despite the “old age” of the U.S. economy, economic growth still looked relatively healthy in the quarter. U.S. real GDP growth came in at 3.2% annualized for the first quarter of 2019. Second quarter GDP growth was not out at the time of this writing, but was projected to be positive, albeit significantly slower, at 1.5%[7].

Wage growth picked up to 3.4% year over year, around the fastest pace of the cycle and the unemployment rate fell to 3.6%, a cycle low[8]. Further, none of the cyclical sectors of the economy, such as autos, housing or business investment spending appeared over-extended.

In contrast to previous cycles, inflation has remained remarkably stable, and has even drifted down so far in 2019. Low inflation often goes hand and hand with slower economic growth and was an important factor in the Fed’s policy shift from rate hikes to expected rate cuts. Central banks around the world echoed the Fed’s dovish message and shifted their policy. The recent gains in the stock market suggested that these policy shifts by central bankers may add extra innings to the bull market and potentially extend the economic cycle.

However, economic risks remain. Why would the Fed lower rates when the stock market is at all-time highs, unemployment is at record lows and we are 10 years into economic expansion? The answer is that they see a potential economic slowdown on the horizon and are trying to avert it.

For example, an inverted yield curve remained in place during the quarter. The chart at left shows the 10-year rate minus the 3- month rate. It is currently negative or “inverted”, meaning short term interest rates were higher than long term interest rates[9].  This dynamic has in the past been a predictor of recession.

In addition, the ongoing trade concerns continued to have a material impact on global trade activity and weighed on business confidence. Growth in global trade fell from the historical 5% average to nearly flat. Export-heavy countries in Europe and Asia has been impacted the most. The U.S. has been relatively insulated because only a small share of our GDP is related to exports[10].

 

 

 

Finally, recent data on manufacturing was weaker than expected. Data continued to weaken over the first half of the year with the global manufacturing PMI falling below the expansion threshold in June, marking the lowest level since February 2016[11]. Weakness was broad-based with the headline number and new orders falling in all regions.

There was reported almost $12 trillion worth of global debt trading at a negative yield[12]. Even though many bonds were already trading at negative yields at the beginning of the second quarter, expectation for Central Bank rate cuts drove them even lower. For example, the yield on Germany’s 5-year bond declined 21 basis points and ended the quarter at a negative yield of 0.66%, while the yield on Germany’s benchmark 10-year bond declined 26 basis points, ending the quarter at a negative yield of 0.33%. At these levels, the 5- and 10-years are trading at their most negative yield ever. U.S. Treasuries are comparatively some of the highest-yielding options despite barely yielding more than the current inflation rate.

Stocks

The S&P 500 Index reached all-time highs during the quarter, just six months after it fell 19.4% between Sept. 21 and Dec. 24, 2018. The strong first half was particularly impressive given slower economic and profit growth. A major factor for the positive performance in equities was the Fed’s pivot from rate hikes to expectations for rate cuts. Interest rates are the price of money and investors love when the cost of money falls. Not only do businesses and consumers pay lower interest rates on their debts but low interest rates influence the discount rates investors use when valuing equities. Lower discount rates make future cash flows from stocks more valuable, often times resulting in higher prices.

Profit growth was extremely strong for most of 2018, but has slowed so far in 2019, to a gain of just 4% year-over-year in operating earnings per share[13]. Investors expected single digit profit growth to continue for the remainder of 2019.

U.S. equities continued outperforming international equities. This was, in part, because of a stronger U.S. dollar and investor’s caution on the potential impact of a trade war on international corporate profits. We believe that it is still important for investors to have a significant allocation towards international equities. In the long run, valuations are lower and a rising U.S. trade deficit could cause the dollar to fall, amplifying the return on international equities. In the short-term, prospects for European growth do not look particularly inspiring, but the slow growth is reflected in low valuations. Emerging markets have the most promising long-term growth prospects with favorable demographics, low valuations and the strongest economic growth.

The following chart helps provide more perspective on quarterly swings in performance. Rather than just displaying the returns, this chart shows the standard deviation (volatility) of different markets relative to their long-term trend[14].

Looking historically at the U.S. and foreign markets’ volatility, the second quarter was less volatile than the first, and both were well below the 10-year average. We saw a big uptick in volatility during the selloff of Q4 2018. It’s surprising that non-U.S. stocks were calmer for many of the past quarters despite their underperformance.

 

 

During the quarter, we saw positive returns for all sector indexes, except for energy, which was down nearly 4%. Year to date, except for healthcare, all sectors produced double-digit total returns, with four sectors exceeding 20%[15].

 

Generally, defensive sectors tend to lag in rising markets. While this has been true so far in 2019, defensive sectors have outpaced more cyclical sectors over the past year. In addition, the more defensive large caps have beaten small caps over the last year and safe-haven assets like bond and gold have performed well.

Since the end of 2013, small cap stocks (Russell 2000 Index) have generated a cumulative total return of 45%, more than 30% behind the S&P 500 (+78%)[16]. As a result, small cap valuations look compelling versus large cap (see chart).

The second half of the year could be a bit bumpy given risks around trade, geopolitics, and reliance on central bank policies. History tells us pullbacks of 5–10% are quite common, while corrections of 10% or more are not rare by any means.

As always, please call if you have any questions or would like to discuss your account in more detail.

 

 

IMPORTANT DISCLOSURES

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

 

This newsletter is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual.  To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All performance referenced herein is historical in nature and is not an indication of or a guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

 

*Your experience may vary according to your individual circumstances and there can be no assurance that LRIA will be able to achieve similar results for all clients in comparable situations or that any particular strategy or investment will prove profitable.   As investment returns, inflation, taxes and other economic conditions vary, your actual results may vary significantly. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore.

 

Stock investing includes numerous specific risks including the fluctuations of dividend, loss of principal, and potential illiquidity of the investment in a falling market. International and emerging markets investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Small cap stocks may be subject to a higher degree of risk than more established companies’ securities. The illiquidity of the small cap market may adversely affect the value of these investments. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. This newsletter should not be regarded as a complete analysis of the subjects discussed. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price. The risks associated with investment-grade corporate bonds are considered significantly higher than those associated with first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. The range of this spread is an indicator of the market’s belief in the stability of the economy. The fast price swings in commodities and currencies can result in significant volatility in an investor’s holdings. There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. The Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time.

 

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors. For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.

 

INDEX DEFINITIONS

The Barclays Aggregate Bond Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment-grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities.

 

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. It cannot be invested into directly.

 

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

 

The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices of approximately 800 stocks and is designed to measure equity market performance in 23 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, , Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey, and the United Arab Emirates.

 

The MSCI EAFE (Europe, Australasia, Far East) Index is a free float-adjusted market capitalization index of approximately 900 stocks and is designed to measure equity market performance in 21 developed market countries outside of North America.[i]

 

 

[1] U.S. Department of the Treasury

[2] Data from Morningstar. Through June 30, 2019. All returns in U.S. Dollars.

[3] Alternatives benchmark includes 50% SG Trend Index, 25% Swiss Re Global Cat Bond TR Index and 25% CBOE Eurekahedge Short Volatility Hedge Fund Index

[4] Bloomberg, “U.S. Economy Celebrates 10 Years of Growth, But No One’s Partying”. June, 2019

[5] JPMorgan Guide to the Markets, 3rd Qtr 2019

[6] LPL Research

[7] Federal Reserve Bank of Atlanta. Based on GDPNow model.

[8] JPMorgan Guide to the Markets, 3rd Qtr 2019

[9] Chart from Koyfin, comparing 3-momth U.S. Treasury bill to 10-year U.S. Treasury Note

[10] JPMorgan, Guide to the Markets. 3re Qtr 2019

[11] T. Rowe Price

[12] Bloomberg

[13] JPMorgan

[14] Morningstar Direct

[15] Data from Morningstar. Based on Morningstar Sector Indexes.

[16] Leuthold Group

[i]

Company News

What was the Highlight of your Summer?

Welcome, Shawn!

Congratulations, Dirk!

Community Involvement: West Valley Dollars for Scholars

New Client Portal Experience

Market Commentary

2022 3rd Quarter Investment Commentary

2022 2nd Quarter Investment Commentary

Market Update: May 2022

2022 1st Quarter Investment Commentary

Market Update: February 25, 2022

Retirement Planning

Medicare Open Enrollment for 2023 Begins October 15th

Social Security Benefit Increase of 8.7% for 2023

The Huge Cost of Doing Nothing

Student Loan Update

Unclaimed Property and Retirement Benefits

Tax Planning

2022 Year-End Tax Planning

Important Ages for Retirement Accounts

Do I Need to Start Making Federal Estimated Income Tax Payments?

Reminders as you Prepare your 2021 Taxes

Washington State Long Term Care Tax on Pause

Cyber Security

Cybersecurity 101 – 2022 Update

Cybersecurity 101

New Changes to Web-Portal Password Requirements

Equifax Data Breach Update: Make a claim today

Cybersecurity 101

Important Disclosures

Leonard Rickey Investment Advisors, PLLC (“LRIA”), is an SEC registered investment adviser located in the State of Washington. Registration does not imply a certain level of skill or training. For information pertaining to the registration status of LRIA, please contact LRIA or refer to the Investment Adviser Public Disclosure website (www.adviserinfo.sec.gov).

This is provided for general information only and contains information that is not suitable for everyone. As such, nothing herein should be construed as the provision of specific investment advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. There is no guarantee that the views and opinions expressed herein will come to pass. This newsletter contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein and take no responsibility therefore.

Any projections, forecasts and estimates, including without limitation any statement using “expect” or “believe” or any variation of either term or a similar term, contained here are forward-looking statements and are based upon certain current assumptions, beliefs and expectations that LRIA considers reasonable or that the applicable third parties have identified as such. Forward-looking statements are necessarily speculative in nature, and it can be expected that some or all of the assumptions or beliefs underlying the forward-looking statements will not materialize or will vary significantly from actual results or outcomes. Some important factors that could cause actual results or outcomes to differ materially from those in any forward-looking statements include, among others, changes in interest rates and general economic conditions in the U.S. and globally, changes in the liquidity available in the market, change and volatility in the value of the U.S. dollar, market volatility and distressed credit markets, and other market, financial or legal uncertainties. Consequently, the inclusion of forward-looking statements herein should not be regarded as a representation by LRIA or any other person or entity of the outcomes or results that will be achieved by following any recommendations contained herein. While the forward-looking statements here reflect estimates, expectations and beliefs, they are not guarantees of future performance or outcomes. LRIA has no obligation to update or otherwise revise any forward-looking statements, including any revisions to reflect changes in economic conditions or other circumstances arising after the date hereof or to reflect the occurrence of events (whether anticipated or unanticipated), even if the underlying assumptions do not come to fruition. Opinions expressed herein are subject to change without notice and do not necessarily take into account the particular investment objectives, financial situations, or particular needs of all investors.

For additional information about LRIA, including fees and services, please contact us for our Form ADV disclosure brochure using our contact information herein. Please read the disclosure brochure carefully before you invest or send money.