Gill Capital Partners October 2019 Market Commentary
“More money has been lost trying to anticipate and protect from corrections than actually in them.”
Peter Lynch
Third Quarter 2019 Market Review
The third quarter saw the return of equity volatility, though most major indices posted flat to modestly negative returns for the quarter and are still showing significant gains for the year. As shown in the chart below, U.S. equities saw a range of returns between -2.5% (small caps) and +1.0% (S&P 500). Emerging markets were down 5% and developed international markets were down 1.5%. Publicly traded real estate (REITs) saw the best returns of all asset classes at just over 6%. Investors seemed to be balancing mostly positive earnings results and lower interest rates with the negative effects of the trade war, heightened political risk in the U.S. and abroad, and the prospect of a slowing global economy. Earnings reports from the second quarter showed sales were relatively flat but earnings grew by roughly 5%. The earnings season revealed a bit of a mixed bag, but in general it was positive and continued to reflect that of a healthy economy that is growing, albeit at a slower pace. The Federal Reserve cut interest rates twice in the third quarter in a proactive attempt to support economic growth. Interest rates fell sharply in the third quarter as a result of Federal Reserve actions, pushing yields on U.S. Treasuries to, or near, historically low levels.
Looking Ahead – Interest Rates & Macro Headlines (Trade Wars, Impeachment & Elections)
As we move into the final quarter of the year, we continue to focus on a few key areas that will be critical to the market direction over the next year.
Interest Rates: As mentioned, the Federal Reserve cut interest rates twice in the third quarter, and the market is expecting further rate cuts.
Our View: While it is true that certain leading indicators (manufacturing, yield curve inversion) are forecasting slower economic growth or even a recession in the not too distant future, currently, economic fundamentals look fine. In fact, the current fundamental economic picture does not seem to necessitate lower interest rates or Federal Reserve accommodation. That being said, it is pretty clear that lower interest rates are here to stay as long as inflation does not pick up materially. Lower interest rates will continue to support consumer and business spending along with equity prices. However, lower interest rates pose a unique challenge to fixed income investors, who now must either increase their risk to make the same return or accept lower returns going forward. Fixed income (specifically, longer maturity bonds) has seen significant and unexpected returns this year, and we have been harvesting these gains and re-allocating fixed income portfolios to reduce risk associated with interest rate movements.
Macro Headlines (Trade Wars, Impeachment & Elections): Macro headlines continue to whipsaw markets, with headlines on trade proving to be the most significant. Many investors don’t understand how the U.S. stock market can be setting record highs with the type of macro and political risk we are currently seeing.
Our View: As we have discussed previously, fundamentals trump macro headlines. While we are certainly in a period of heightened political and macro risk, the fundamentals remain strong, and valuations are reasonable at roughly 16.5 times earnings. The forward P/E ratio on the S&P 500 is essentially right at its long term average, as compared to 24 times earnings during the height of the dot-com bubble. So, while stocks are not a screaming bargain here, they are not wildly overpriced either. Trade remains the most important wild card for the markets. Any sort of trade deal that will allow China and the U.S. to back off on tariffs will likely send markets much higher, particularly emerging market equities. As of this writing, there seems to be renewed hope that progress is being made and that at least a partial deal can be struck. A lack of progress at this meeting or further escalation of tariffs will likely have the opposite impact on markets.
Conclusion
Our Investment Committee recently completed our semi-annual strategic review, and we have updated our outlook. We are positioning portfolios slightly more conservatively than we have over the past few years, as we are cognizant that the current economic expansion is showing signs of age. When combined with the heightened level of political risk (trade, etc.), it seems to make logical sense to be a bit more careful here. That being said, we still believe strongly in the benefits of investing in the stock market over the long-term; we are simply doing some housekeeping and adding a little “bubble wrap” in case we see volatility pick up.
Breaking News – Free Trading: Charles Schwab sent shockwaves through the brokerage community last week when it announced that it would eliminate commissions for stocks, ETFs and options listed on U.S. and Canadian exchanges. This announcement was quickly followed by similar announcements by TD Ameritrade, Fidelity and E*Trade. Mutual fund trading commissions were not eliminated as part of this move and mutual fund trades still may carry fees.
Our View: The major brokerage firms have been moving this direction for years, cutting trading fees dramatically over the past decade. While a wide variety of investments have traded for free for some time, this removes any remaining barriers that trading fees may have presented for investors. We see this as a good thing that benefits the investing community. Trading costs are an input into our investment selection process, and it is possible that this change may open up new investment options that may not have been as attractive from an overall cost perspective prior to this shift.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.