Quarterly Commentary

The Cornerstone Investment Commentary: 2nd Quarter 2019

It’s been quite some time since the Federal Reserve’s (the Fed’s) monetary policy held such sway over the near-term performance of stock and bond markets.  Yet that’s exactly where we find ourselves.

Nine months ago, the Fed’s continuing interest rate hikes sent global stock markets to their worst quarter (October-to-December 2018) since the Great Recession.  By year-end, its announcement that these increases would “pause” propelled these same markets, in anticipation that the Fed’s next move would be an interest rate cut, to their best six months in over five years.  This volatility was exacerbated by uncertainty about U.S. trade policy, with tariff impositions making last Fall’s decline even worse and their subsequent relaxation (until May, at least) making this Spring’s gains larger.  How did this affect stock market performance?  Both the widely-followed All-Country World Index (ACWI), a ~55% U.S. and ~45% foreign blend, as well as the U.S. stock market are each up just 1.8% over the entire nine months.

At the same time, corporate profits – the key long-term driver of stock prices – rose less than 4% in the first quarter versus one year prior.  In addition, job creation is running about 25% behind 2018’s pace, and annual inflation has slipped below 2%.  Each of these signifies a slowing economy and brings the ‘r-word’ … recession … into the conversation.  Hence, the importance of the Fed’s actions in the coming months.

Try as they might, it’s no wonder that stocks can’t push materially higher than they hit last September.  It will take a fundamental improvement in economic conditions and/or corporate profits for this to happen:  specifically, the Fed deciding to lower interest rates repeatedly during the rest of 2019.  If they don’t (or don’t do so ‘sufficiently’), stock market performance is more likely to turn negative than to rise further.  It’s for this reason that your portfolio’s equity (stock) allocation remains in a more conservative posture than usual, about one-tenth lower than if conditions weren’t so tenuous.

The bond market reacted with similar volatility with its first negative year (2018) in over a decade; then came a strong 2019 rally as the Fed reversed course on future interest rate direction.  Holding exclusively short-term bonds in 2018 helped your portfolio weather that storm with positive results, and our portfolio change earlier this year to begin adding back intermediate-term bonds has already proven profitable.

Given this state of affairs … 1) the likelihood of at least some interest rates cuts in the coming quarters; 2) a still modestly-growing economy but with both profit growth and inflation slowing; and 3) a (seeming) preference to avoid a ‘trade war’ but with this uncertainty stifling business investment … we believe your portfolio is well-positioned.  That said, any significant changes to this situation could cause us to adjust your portfolio’s allocation strategy, and we would – of course – be in touch with specifics and our rationale.

Finally, we send our sincere wishes that you and your family will enjoy this summer and thank you for the continuing opportunity to work with you.

 

Past Commentary