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Better-than-Expected but Not-So-Great Economy

November 2019

US Economy: Tepid growth beats expectations.

US GDP for 3rd quarter 2019 grew at an 1.9% annualized rate, just below the 2nd quarter result (2.0%) but higher than analyst estimates. While US consumer spending (+2.9% for 3rd qtr.) remains relatively strong and the job market healthy, business investment continues to slip (-1.5% in 3rd qtr.) alongside persistent trade uncertainty.

US Stocks: Lower profits beat estimates.

The 40% of S&P 500 companies reporting so far for 3rd quarter 2019 showed a drop in earnings of nearly 4% vs. the year-earlier period. However, these results beat analyst estimates and corporate revenue has been growing. Small caps have more recently begun to outperform since their earnings are generally less affected by the strong US dollar.

Foreign Stocks: Trade news boost EM.

Foreign equities outperformed US stocks with strong results in the emerging markets (EM). Emerging market stocks have been stuck in a bit of limbo as the trade war ebbs and flows but a partial agreement between the US and China, as well as central bank stimulus, have helped them break out.

Fixed Income: How low will the Fed go?

The Fed cut its target interest rate for the 3rd time in 2019, to the 1.5% – 1.75% range, as US economic data has weakened. Still, Fed Chair Jerome Powell strongly hinted that this latest cut is likely to be the last for the foreseeable future, acknowledging that prior cuts have begun to have a positive impact.

Real Assets: Gold, commodities rally.

Commodities led the real assets category in October. While weak global growth and rising inventories were a headwind for oil, gold and other precious metals performed well as perceived safe havens and a bet on accommodative monetary policy.

Alternatives: Hedge funds in the black.

Generally, hedge funds were up in October. Rallying equity markets were supportive of equity hedge and event-driven strategies, while volatile interest rate markets whipsawed systematic macro strategies.

Equities Total Return

U.S. Large Cap 2.2% 23.2% 14.3%
U.S. Small Cap 2.6% 17.2% 4.9%
U.S. Growth 2.8% 26.2% 16.3%
U.S. Value 1.5% 19.2% 10.6%
Int’l Developed 3.6% 16.9% 11.0%
Emerging Markets 4.2% 10.4% 11.9%

Fixed Income Total Return

U.S. Agg. Bond 0.3% 8.8% 11.5%
TIPS 0.3% 7.9% 9.0%
U.S. High Yield 0.2% 11.8% 8.3%
Int’l Developed 0.6% 5.7% 8.8%
Emerging Markets 1.6% 6.1% 11.0%
Intermediate Munis 0.4% 4.8% 6.8%
Munis Broad Mkt 0.1% 7.2% 9.6%

Non-Traditional Assets Total Return

Commodities 2.0% 5.2% (2.6%)
REITs 1.1% 29.9% 25.3%
Infrastructure 1.5% 22.7% 21.1%
Hedge Funds
Absolute Return 0.5% 3.3% 1.8%
Overall HF Market 0.2% 6.2% 3.5%
Managed Futures (2.5%) 5.9% 6.2%

Economic Indicators

OCT-19 APR-18 OCT-18
Equity Volatility 13.2 13.1 21.2
Implied Inflation 1.6% 2.0% 2.1%
Gold Spot $/OZ $1513 $1284 $1215
Oil ($/BBL) $60 $73 $75
U.S. Dollar Index 92.0 92.3 90.8

Glossary of Indices

Our Take

The general sentiment among investors seems to be one of pessimism, and with good reason: Much of forward-looking US economic data has softened (if not outright contracted) and the Fed has, in an about face from a year ago, cut interest rates to support the economy three times within a four-month period. While we won’t argue that it’s best to make hay while the sun shines, (we have been taking steps to reduce the risk in our portfolios throughout 2019), it does seem possible that investor concerns are overdone and exaggerate the most likely downside when the long-running US expansion does finally run out of steam.

For one, the US appears much healthier and better positioned than most of its trading partners. Also, US consumers continue to be the key driver of the US economy, and the job prospects and finances of households are still strong. Lastly, within the financial markets, valuations are not egregious in equities nor fixed income. Before the last recession (2008-2009), none of these factors were positive and the results were painful. It seems that today an economic pause or slowdown is a much more likely outcome, even if the steep declines of a decade ago continue to haunt investors.

In terms of portfolio positioning, we remain marginally biased toward risk reduction and recommend topping up exposures to core fixed-income and other more defensive sectors, such as infrastructure equities. That said, the strong results we have seen year-to-date have in large part just offset difficult performance from last year leaving portfolios at reasonable valuations, not lofty peaks. At this time, we don’t recommend investors make dramatic shifts as there remains upside in our view, and we believe our portfolios are well-positioned should a downturn materialize.