Q1 2019 Are we out of the woods
COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q1 2019 - Are we out of the woods?
The extreme volatility that ended 2018 quickly faded away and calmer seas prevailed as we turned the calendar to 2019. Just like a phoenix rising from the ashes, so have the markets. The strongest return came from the technology heavy NASDAQ which led U.S. indices with a quarterly gain of +16.81%. The S&P 500 climbed +13.65% in the quarter, which marks the 11th time the broad index has gained more than 10% in a first quarter since 1950. The recent moves higher around the globe caught many investors off guard as investors were still in defensive mode as opposed to offense. On the economic front, employment data released for the quarter was mixed with a lower than expected job creation, however, the unemployment rate remains below 4.0% and wage growth continues to increase but not alarming enough to warrant an inflation scare. With the 2019 GDP estimates around 2.0%, the U.S. economy appears to have peaked for now in 2018 with a 2.9% growth rate. Preliminary GDP estimates for Q1 2019 are around 1.7%. Earnings season begins in mid-April with earnings growth expectations anticipated to decline -1.9% for the quarter. The decline is not surprising as the corporate environment returns to normal following the positive tax reform initiatives of 2018.
At March's Federal Open Market Committee meeting, there was a shift in the Federal Reserve's message that reflects a changing of current economic data. They no longer expect to raise the Fed Funds Rate for the foreseeable future and will leave the rate unchanged at 2.50%. This is a vast contrast from December's meeting, which was full of hawkish rhetoric that predicted additional rate hikes. Federal Reserve Chairman, Jerome Powell, took it a step further by stating recently that they would reduce the Federal Reserve balance sheet and pause further reductions indefinitely starting in September. This policy shift caused bond yields to collapse as global growth slowdown cries grew louder. The 10-year treasury note yield fell below the yield of the 3-month treasury bill causing an inverted yield curve for the first time since 2007. The inversion of the yield curve has investors unnerved and cautious since it is viewed by many as a recession indicator. Historically, this has signaled a possible recession, but the Investment Committee believes that the U.S economy remains fundamentally strong and hasn't been subjected to any major weakness like some other parts of the world such as Europe. The economic stresses that have been manifesting overseas has our attention but have largely been contained to those respective geographies. The 10-year Treasury yield ended the quarter 2.41% moving 28 basis points lower, or 0.28%, since 12/31/2018. The yield curve tightened further with the 2-year and 10-year yield difference at 14 basis points for the quarter. Foreign bonds are up YTD while the Barclays Aggregate Bond Index closed the quarter with a +2.94% gain.
International markets are participating in the rally with the MSCI EAFE Index closing the quarter up +9.98% while Emerging Markets were up +9.92%. The ECB President, Mario Draghi, announced that their central bank is prepared to support the Eurozone economy by delaying policy tightening and unveiling a new round of stimulus by offering banks cheap loans to help revive their struggling economy. We believe the pause in interest rate increases and additional stimulus measures surfacing around the world are supportive of equities in the medium-term.
THOUGHTS ON ASSET ALLOCATION
Given the magnitude of the fourth quarter selloff and the dovish policy shift by the Federal Reserve that led to the current rally, investors need to be mindful of market timing. Market retreats like the one in Q4 2018 can be unnerving and cause ill-advised reaction by many investors. As professional advisors for our clients, we stress the importance of staying diversified and committed to long-term goals as the markets make their way through episodes of dislocation. This tactic certainly worked to everyone's benefit over the last six months as our client portfolios are back to their September 2018 levels. We did not make costly asset allocation adjustments in the quarter as our focus remained fixed on valuation and earnings expectations for the next couple quarters. We continue to maintain a "value" tilt in our portfolios but have complimented this stance with high quality growth in select areas. As we navigate through the year, the market backdrop will largely depend on the tariff fight outcome and Federal Reserve positioning. So far, we only have clarity on one of these items.
Regardless of the market environment, we always seek to select superior managers in both our equity and fixed income portfolios. Most of our managers outperformed their benchmark by significant margins to close out the quarter even in an environment where market preferences aligned with momentum and generally lower quality. Listed below is a subset of our equity and fixed income managers that performed exceptionally well in the quarter.
Q1 2019 - Are we out of the woods?
The extreme volatility that ended 2018 quickly faded away and calmer seas prevailed as we turned the calendar to 2019. Just like a phoenix rising from the ashes, so have the markets. The strongest return came from the technology heavy NASDAQ which led U.S. indices with a quarterly gain of +16.81%. The S&P 500 climbed +13.65% in the quarter, which marks the 11th time the broad index has gained more than 10% in a first quarter since 1950. The recent moves higher around the globe caught many investors off guard as investors were still in defensive mode as opposed to offense. On the economic front, employment data released for the quarter was mixed with a lower than expected job creation, however, the unemployment rate remains below 4.0% and wage growth continues to increase but not alarming enough to warrant an inflation scare. With the 2019 GDP estimates around 2.0%, the U.S. economy appears to have peaked for now in 2018 with a 2.9% growth rate. Preliminary GDP estimates for Q1 2019 are around 1.7%. Earnings season begins in mid-April with earnings growth expectations anticipated to decline -1.9% for the quarter. The decline is not surprising as the corporate environment returns to normal following the positive tax reform initiatives of 2018.
At March's Federal Open Market Committee meeting, there was a shift in the Federal Reserve's message that reflects a changing of current economic data. They no longer expect to raise the Fed Funds Rate for the foreseeable future and will leave the rate unchanged at 2.50%. This is a vast contrast from December's meeting, which was full of hawkish rhetoric that predicted additional rate hikes. Federal Reserve Chairman, Jerome Powell, took it a step further by stating recently that they would reduce the Federal Reserve balance sheet and pause further reductions indefinitely starting in September. This policy shift caused bond yields to collapse as global growth slowdown cries grew louder. The 10-year treasury note yield fell below the yield of the 3-month treasury bill causing an inverted yield curve for the first time since 2007. The inversion of the yield curve has investors unnerved and cautious since it is viewed by many as a recession indicator. Historically, this has signaled a possible recession, but the Investment Committee believes that the U.S economy remains fundamentally strong and hasn't been subjected to any major weakness like some other parts of the world such as Europe. The economic stresses that have been manifesting overseas has our attention but have largely been contained to those respective geographies. The 10-year Treasury yield ended the quarter 2.41% moving 28 basis points lower, or 0.28%, since 12/31/2018. The yield curve tightened further with the 2-year and 10-year yield difference at 14 basis points for the quarter. Foreign bonds are up YTD while the Barclays Aggregate Bond Index closed the quarter with a +2.94% gain.
International markets are participating in the rally with the MSCI EAFE Index closing the quarter up +9.98% while Emerging Markets were up +9.92%. The ECB President, Mario Draghi, announced that their central bank is prepared to support the Eurozone economy by delaying policy tightening and unveiling a new round of stimulus by offering banks cheap loans to help revive their struggling economy. We believe the pause in interest rate increases and additional stimulus measures surfacing around the world are supportive of equities in the medium-term.
THOUGHTS ON ASSET ALLOCATION
Given the magnitude of the fourth quarter selloff and the dovish policy shift by the Federal Reserve that led to the current rally, investors need to be mindful of market timing. Market retreats like the one in Q4 2018 can be unnerving and cause ill-advised reaction by many investors. As professional advisors for our clients, we stress the importance of staying diversified and committed to long-term goals as the markets make their way through episodes of dislocation. This tactic certainly worked to everyone's benefit over the last six months as our client portfolios are back to their September 2018 levels. We did not make costly asset allocation adjustments in the quarter as our focus remained fixed on valuation and earnings expectations for the next couple quarters. We continue to maintain a "value" tilt in our portfolios but have complimented this stance with high quality growth in select areas. As we navigate through the year, the market backdrop will largely depend on the tariff fight outcome and Federal Reserve positioning. So far, we only have clarity on one of these items.
Regardless of the market environment, we always seek to select superior managers in both our equity and fixed income portfolios. Most of our managers outperformed their benchmark by significant margins to close out the quarter even in an environment where market preferences aligned with momentum and generally lower quality. Listed below is a subset of our equity and fixed income managers that performed exceptionally well in the quarter.
Investment Manager / * Q1 2019 Return / Manager Benchmark
Granite Small Cap Growth / +23.43% / +17.14% Russell 2000 Growth
Confluence International / +16.59% / +10.13% Russell 1000 Growth
T. Rowe Price Emerging Markets / +13.83 / +9.91 MSCI Emerging Markets
Cullen High Dividend Value / +11.80% / +11.93% Russell 1000 Value
AB Long/Short Equity Fund / +6.47% / +0.06% Morningstar Mrk Neutral
PIMCO Investment Grade Bond / +5.53% / +2.32% Barclays Intm Gov/Cred
*Returns are expressed as composite returns. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214
Granite Small Cap Growth / +23.43% / +17.14% Russell 2000 Growth
Confluence International / +16.59% / +10.13% Russell 1000 Growth
T. Rowe Price Emerging Markets / +13.83 / +9.91 MSCI Emerging Markets
Cullen High Dividend Value / +11.80% / +11.93% Russell 1000 Value
AB Long/Short Equity Fund / +6.47% / +0.06% Morningstar Mrk Neutral
PIMCO Investment Grade Bond / +5.53% / +2.32% Barclays Intm Gov/Cred
*Returns are expressed as composite returns. Results may vary. Past performance is no guarantee of future returns
We look forward to speaking with all of you regarding our views and the performance of your respective portfolios. For additional information or questions please contact Mason Williams, Chief Investment Officer, at 786-497-1214