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ECONOMIC FLASH – A Good Time to Reduce Risk, Moderately

May 2019

US Economy: GDP gets a lift.

Q1 US GDP growth surprised to the upside (+3.2%), but the underlying data was less rosy. Growth was driven by net exports (+1.0%), inventory restocking (+0.7%) and a spike in state and local government spending (+0.4%), all of which are likely to prove transitory.

US Stocks: Another good month.

April was another strong month for US equities, with more than 75% of S&P 500 companies reporting Q1 profits beating analyst estimates so far. Market returns were driven by the technology and financial sectors, up 6.4% and 9.0% in April, respectively.

Foreign Stocks: Disappointing data.

With the US dollar stable, currency wasn’t a significant detractor for foreign stocks. However, while European equities gained overall, Asian stocks lagged on concerns about slowing growth in China and a weaker outlook for microchip producers, which are a large component of Asian stock indexes.

Fixed Income: Risk-on is back.

A slight rise in US interest rates hindered high-quality fixed income but not lower-quality, high-yield bonds. Year-to-date, higher-yielding sectors — including bank loans and emerging market debt denominated in US dollars — have benefitted as investors focused on income and less on risk.

Real Assets: Infrastructure leads.

Infrastructure equities posted the strongest returns within real assets in April, while REITs took a step backward, as we had anticipated, due to vulnerability to slightly higher interest rates. As a subset of equities, infrastructure has compelling characteristics from both a risk and return perspective.

Alternatives: Hedge funds lag.

Managed futures posted another strong month capitalizing on persistent trends, while hedge fund strategies posted modest returns. In aggregate, hedge funds haven’t kept up with stock and bond market returns, even though managers long on equities have found relative success in a rising market.

Equities Total Return

APR YTD 1 YR
U.S. Large Cap 4.0% 18.2% 13.5%
U.S. Small Cap 3.4% 18.5% 4.6%
U.S. Growth 4.4% 21.3% 16.6%
U.S. Value 3.6% 15.9% 8.6%
Int’l Developed 2.8% 13.1% (3.2%)
Emerging Markets 2.1% 12.2% (5.0%)

Fixed Income Total Return

APR YTD 1 YR
Taxable
U.S. Agg. Bond 0.0% 3.0% 5.3%
TIPS 0.3% 3.5% 3.1%
U.S. High Yield 1.4% 9.1% 6.7%
Int’l Developed (0.7%) 0.6% (2.3%)
Emerging Markets (0.9%) 2.1% (0.7%)
Tax-Exempt
Intermediate Munis 0.1% 2.2% 5.0%
Munis Broad Mkt 0.4% 3.4% 6.1%

Non-Traditional Assets Total Return

APR YTD 1 YR
Commodities (0.4%) 5.9% (8.0%)
REITs (0.2%) 16.9% 19.6%
Infrastructure 1.2% 15.5% 7.9%
Hedge Funds
Absolute Return 0.3% (0.9%) (0.0%)
Overall HF Market 0.7% 3.3% (2.8%)
Managed Futures 2.7% 4.7% 1.4%

Economic Indicators

APR-19 OCT-18 APR-18
Equity Volatility 13.1 21.2 15.9
Implied Inflation 2.0% 2.1% 2.2%
Gold Spot $/OZ $1284 $1215 $1315
Oil ($/BBL) $73 $75 $75
U.S. Dollar Index 92.8 90.8 86.4

Glossary of Indices

Our Take

In the last month, little has changed to dissuade us that the US economy will continue to advance at a modest pace. It is likely that the surprisingly robust Q1 GDP 2019 growth figure is indeed transitory: Consumption and investment, both of which were weaker in Q1, are the long-run drivers of US growth. This opinion is apparently shared by Fed Chair Jerome Powell and his committee. The Fed elected to keep its target interest rate unchanged, acknowledging that core inflation has yet to run above the benchmark 2% rate even though unemployment remains at 50-year lows. Neither we nor the financial markets expect interest rates to rise substantially in 2019.

With a positive backdrop in the US, and global economies now generally tilted toward accommodative fiscal and monetary policies, we see support for further market gains given that equity and bond valuations are reasonable. Corporate earnings for Q1 2019, while anticipated to show a 2% drop year-over-year, are just about flat, beating expectations. Granted, there has been wide dispersion between winners and losers. At this point, it appears the major risk to US markets could be geopolitical, perhaps a flare-up in global trade tensions instead of anticipated resolution.

As equity markets have continued to storm ahead, we have taken small but meaningful steps to reduce risk in portfolios. No, we don’t think it’s time to “Sell in May and go away” but we are reducing risk marginally, as opportunities are presented: An ounce of prevention is worth a pound of cure. That said, we continue to emphasize areas that have not seen quite the same enthusiasm from investors, such as emerging markets, and global infrastructure, which in the US seems to be gaining political support for new investment.