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1st Quarter 2019 Private Investment Management Commentary

Pumping the Brakes Following a Fast Start to 2019 

In our January commentary reviewing 2018 and our outlook for 2019, we outlined three main reasons we expected better returns for 2019 compared to 2018. These included an expected rate hike pause from the Fed, higher bond yields to start the year, and favorable stock valuations following the ugly end to 2018. 

The start to 2019 surpassed even our favorable outlook for both stock and bond returns. US stock indexes increased in the 12-16% range for the quarter. These types of returns are typically considered a good year for stocks, not just for one quarter. However, we believe it is important to remember that even with this extremely strong start to the quarter, US stocks are still down over the past 6 months. Put another way, we experienced a very strong start to 2019, but we are still not at all-time highs for stocks.

Bonds also performed well to start 2019 with high quality bonds such as US Treasuries showing strong returns for the quarter as interest rates declined. Recall that interest rates increased meaningfully during the first part of 2018 leading many investors to question their allocation to bonds as bonds experienced negative returns. However, when stocks declined sharply in December 2018 on growth concerns, bonds showed their merit with the main bond index (BC AGG) returning around 2% for the month of December. Interest rates declined further to start 2019 as the Fed continued to communicate a patient outlook for further interest rate increases and whispers of potential rate declines started to circulate. 

The Fed’s expected rate hike pause is warranted in our view with Q1 2019 US GDP growth expected to be around just 2% and Q1 corporate earnings expected to decline for the first time since Q2 2016. In this slowing economic environment, we prefer to own stocks from companies with quality earnings, not high-yield junk bonds, for higher potential returns. We are concentrating our bond allocations in higher-quality positions aimed to provide protection in the event stocks decline as they did in December 2018. At times it can seem counterintuitive, but we prefer increasing the length of bond maturities when bonds experience negative returns due to increasing interest rates as they did in the first part of 2018. We then look to decrease the length of bond maturities when bonds experience strong performance due to declining interest rates. Following the decline in interest rates to start 2019, we are looking to potentially reduce the maturity of our bond positions in this environment.  

Bottom Line

2019 is off to a very fast start and we expect more tempered returns for the remainder of 2019. Currently, we view the stock market as taking a “Goldilocks” view regarding growth, inflation, a US/China trade deal, and the Fed. In our view, it is not likely that this balance remains if US economic growth and wage inflation start accelerating or there is a breakdown in trade negotiations. 

If growth and inflation expectations increase, the Fed will likely start communicating potential further interest rate hikes causing bonds and interest rate sensitive stocks to struggle. Alternatively, if economic growth slows further and/or trade negotiations fall apart, there will likely be talk of a potential recession and worldwide corporate profits will appear threatened (very similar to December 2018). In this scenario, we believe stocks struggle and high quality bonds perform well. Not knowing which of the above scenarios will come to fruition, we continue advocating a diversified portfolio of both stocks and bonds consistent with the long-term risk tolerance for our clients.