Q4 2019 Banner Year and the Art of the Phase One Trade Deal
COMMENTARY FROM THE INVESTMENT COMMITTEE OF CORAL GABLES TRUST COMPANY
Q4 2019 Banner Year and the Art of the Phase One Trade Deal
Markets marched to all-time highs as geopolitical uncertainty, trade disputes and investor concerns over a weakening economy slowly abated. Just twelve months ago, the mood was far dimmer as investors feared the Federal Reserve's interest rate increases would turn an economic slowdown into a protracted downturn. Investors climbed the trade wall of worry all year, however, the S&P 500 marched higher with a +8.1% return for the quarter closing out the year with a +31.5% gain. The technology heavy NASDAQ generated a robust quarterly gain of +11.8% and ended the year with a +35% gain. On the economic front, employment data released for December surprised to the upside with a thriving jobs headline number. The unemployment rate fell to a half-century low at 3.5% and wage growth grew at the best levels in 10 years while inflation was contained. The U.S. economic growth slowed in 2019 due to weak business investment and manufacturing activity, however, consumer spending and services remain bright spots as we head into 2020. Earnings growth for the year was lackluster, but we believe that the low bar will pave the way for modest earnings growth for 2020. With fourth quarter earnings around the corner, investors are anxiously awaiting to see if earnings growth will be better than analyst forecasts of a year-over-year decline of -2.4%.
The United States and China have agreed, in principal, on a phase one trade deal which will result in a reduction of U.S. tariffs on Chinese goods while boosting Chinese purchases of American agricultural, energy and manufactured goods. Phase one will establish the framework for addressing the more sensitive issues of intellectual property and policy enforcement. As an act of good faith, the administration did not proceed with the 15% tariff that was scheduled to go into effect on December 15th on nearly $160 billion worth of Chinese consumer products. The United States de-escalated trade disputes further by reducing the tariff rate it imposed back on September 1st on a $120 billion list of Chinese goods to 7.5% from 15%. The tariff cuts will allow China to import more from the United States without violating international trading rules that ban managed trade. Investors applauded this preliminary trade deal which is the main reason behind the market's strong performance in the back half of 2019.
The Federal Reserve successfully normalized the yield curve by cutting interest rates three times in 2019. At December's Federal Open Market Committee meeting, the Federal Reserve left interest rates unchanged and the Committee believes that the current monetary policy stance is appropriate to sustain the expansion. For the first time since May, the Federal Reserve's Committee members are on the same page as there were no dissents among voting members. Chairman Powell stated that the Federal Reserve is firmly committed to the 2% inflation goal. With inflation pressures muted, this is an indication that the Federal Reserve will be holding steady on future rate moves for the foreseeable future.
Despite the brief yield curve inversion, fixed income remains robust producing equity like returns. The 10-year treasury ended the year at 1.92%, declining 77 basis points, or -0.77% lower, since 12/31/2018. With recessionary fears easing, the yield curve is slowly steepening as the two and 10-year yield difference is 34-basis points (bps) compared to the 5-basis point (bps) difference last quarter. Foreign bonds were up +7.76% for the year, while the Barclays Aggregate Bond Index was higher by +8.72% for the year. High Yield was the best performing fixed income segment in traditional U.S. fixed income which comes to no surprise due to the strong correlation to the equity market.
THOUGHTS ON ASSET ALLOCATION
While investors have every reason to toast the end of a record year and this spectacular decade of financial market gains, caution is warranted, and valuations should be respected. Our Trust Investment Committee thoroughly reviewed our positioning for 2020 and elected to make changes in the mid-cap value and small-cap equity space by adding the Victory Sycamore Established Value strategy and the Baron Small Cap strategy. Extensive due diligence was performed on these strategies and they possess attributes we look for like a proven investment process, conviction and most importantly emphasis on downside protection. We also elected to reduce our REIT (real estate) exposure in favor of a slightly higher exposure in our defensive merger arbitrage strategy.
We remain confident that we have selected superior managers, which will continue to protect and perform regardless of market conditions. Most of our managers had positive double-digit returns for the year with many outperforming their respective mandates. With market valuations at multi-year highs based on most valuation metrics, having an entire roster dedicated to downside protection is the primary focus of the Investment Committee. Listed below is a subset of our equity and fixed income managers that yielded phenomenal results compared to their respective benchmarks in 2019.
Investment Manager / *2019 Return / Manager Benchmark
Polen Capital Large Cap Growth / +39.17% / +36.39% Russell 1000 Growth TR
Alta Capital Large Cap Quality Growth / +34.88% / +31.49% S&P 500 TR
T. Rowe Price Emerging Markets / +26.55% / +18.42% MSCI Emerging Markets NR
PIMCO Investment Grade Bond / +14.77% / +6.80% Barclays Intm Gov/Cred
Blackrock High Yield Bond / +15.28% / +14.32% Barclays US Corp HY
*Returns are from actual portfolio results. 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