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The Cornerstone Investment Commentary: 4th Quarter 2018

Happy New Year!  With the U.S. economy clearly ‘downshifting’ into a period of slowing and slower economic growth, global stock markets produced a rough ride as they shifted into reverse with the worst quarter’s performance of the decade.  Numerous factors – tougher conditions for 2019 corporate profits, increased interest rates, rising wages, a volatile trade/tariff landscape and, most importantly, the uncertainties  these create – brought an end to the ‘perfect investment conditions’ of the last few years.

Though the economy and corporate profits are still growing, inflation is modest and interest rates are low by historical standards, after declines of about 15%, it almost no longer matters whether this slowdown actually becomes a recession.  What does matter is that for the past few years, your equity allocation has been about 1/10 lower than it would be with more fairly-valued markets.  Were U.S. equity declines to exceed 25% from their September highs (when the Dow hit 26,800 and the S&P 500 reached 2,930), it could be a compelling opportunity for us to increase these holdings.

It also matters that conditions are not at all like 2000 or 2008 when stock markets last declined over 25%.  Those occurred when a significant part of the economy was grossly over-valued:  technology stocks in 2000 and real estate in 2008.  While such conditions lead to the biggest declines, they do not exist today.  Today’s conditions are most like 1990, when a short recession began after sustained economic growth and low inflation.  Back then, the stock market’s drop was about 20% from October 1989 to the following Fall.

Based on all this, we feel your portfolio is properly positioned given the costly mistakes that often come from making predictions.  Even if market timing could sidestep a decline, it is for naught if our step ‘back in’ isn’t also correct.  The futility of even trying shows well in the recent results of major equity classes:

2015 2016 2017 2018 2019

U.S. Large-Cap Stocks (S&P 500)

+ 0.9%

+11.8% +21.8% – 4.4% ???

U.S. Small-Cap Stocks (Russell 2000)

–  4.4% +21.4% +14.7% -11.0%


Foreign Stocks (Developed + Emerging)

–  0.9% + 4.5% +27.2% -14.6%


In 2018, it paid off to not follow the crowd to increase foreign stocks and lower U.S.; the U.S. is still best-positioned to weather slowing growth.  The same is true for our much lower small-cap allocation relative to large.  Additionally, over 80% of your portfolio’s active managers bested their benchmarks last year.

As for fixed income, short-term holdings (100% of your bond holdings) out-performed intermediate-term bonds by 1.5%, and our shift to this position a year ago worked well.  However, with the economy slowing and the Federal Reserve reconsidering future interest rate hikes, conditions are shaping up to again hold some intermediate-term Government bonds.  This will likely occur sometime in 2019.

Of course, we will be watching how markets react to unfolding economic and political events this year. With all wishes for a healthy and happy 2019, thank you for the continuing opportunity to work with you.