2019 Half-Time Report

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2019 has been an exciting year. Please read our thoughts on the first six months of the year, and see our strategies for the second half. To access your performance reports, you must log-in to your secure community.

Market Recap

Back in January, after the painful market downturn in the fourth quarter, we said we saw scenarios that could make markets rise or fall in the near term and that we would take a middle path taking both into account. And both is what we got during the first half of 2019. However, the sharp downturn in May was short, and following a strong June most asset classes posted nice gains for the six months ended June 30, 2019.

All asset classes rose during the second quarter, as progress in U.S.-China trade negotiations and a newly dovish (accommodative) Federal Reserve buoyed investors. The S&P 500 hit a new high near the end of June. Large-cap U.S. stocks shot up 7.0% for the second quarter, and a remarkable 18.5% for 2019’s first half. Although emerging markets stocks were only up 0.8% for the second quarter, their first-half gains stand at 12.6%.

Fixed income also gained, as the 10-year Treasury yield fell below 2.0% on the heels of the Fed’s willingness to cut, rather than raise rates at their June meeting. When bond yields fall, their prices rise. The core bond index gained 3.0% for the quarter and 6.1% year-to-date. Floating-rate loans gained 1.7% for the quarter and 5.7% for the year.

Our small allocation to alternative investments also gained.

Please find enclosed your reports for the second quarter of 2019. YOU MUST LOG-IN TO YOUR SECURE VAULT TO ACCESS YOUR STATEMENTS.

A Mix of Risks Persists

Could the second half of 2019 also deliver such positive returns? We don’t say “never,” just as we don’t rely on short-term predictions to drive our investing. The five-year outlook that influenced our views in January remains generally intact. However, risks to global markets have increased somewhat – including the potential escalation of a trade war and conflict with Iran – and with valuations even higher than they were, similarly robust second-half 2019 returns seem less likely.

The Fed’s changing stance and a shift toward loosening by other central banks, including the European Central Bank and stimulus by the People’s Bank of China, were a plus and this typically lifts global markets and asset prices. However, the market now generally anticipates at least one Fed rate cut during 2019. It’s possible that stock prices already fully reflect the impact of potential Fed rate cuts, so an actual rate cut may not have the power to lift prices further. And if the Fed fails to cut rates, that could potentially hurt stock prices as it rattles markets that were expecting more.

Another concern is the length of the U.S. economic cycle. The U.S. is now experiencing one of the longest runs of economic growth in our history. Each quarter brings this economic cycle closer to its end. Of course, there’s no way to know how long an economic cycle can run. However, quite a few leading economic indicators have turned negative. It seems likely that the U.S. will experience a recession at some point during the next few years. And it’s certainly possible that we could see a recession in the next 12 months, which is why making modest adjustments to our portfolios to provide more explicit protection against that possibility is something we’re seriously contemplating. This, in turn, lets us use our “risk budget” where we want it – one way to think of it is as a “barbell” with a little stronger downside protection on one end and exposure to higher returning investments on the other.

The increasingly stretched valuations of many riskier assets like stocks are a related concern. They make it harder to justify paying current prices for stocks, especially in the U.S. This is less true in Europe and emerging markets, where stock prices reflect expectations that may be overly pessimistic. That’s why we’re underweight U.S. stocks, and overweight European and emerging market stocks. While the length of time U.S. stocks have outperformed is frustrating, we know that in the long run fundamentals and valuations converge Therefore, we make investment decisions on longer-term normalized valuations, which we can analyze with confidence, and not timing, which we can’t.

If global economies and markets turn negative, our core bond holdings, other fixed income, and alternative investments will provide cushioning against broader stock market declines. Still, with rates very low there is less cushioning from bonds and in a bad downturn we could see losses greater than our 12-month target loss thresholds. This is part of the trade off in balancing the negative with the positive.

On the other hand, to consider the positive, if global economic growth begins to recover from its current low levels, we expect the more cyclical value stocks held by many of our managers to benefit. These are stocks in the financials, consumer discretionary, and technology sectors that historically have benefited most from economic recovery as people begin to spend more on non-essentials. During the past year, these stocks have lagged stocks in the sectors considered defensive—such as utilities, REITs, and consumer staples—because they benefit from spending that varies less with the state of the economy. Our more economically sensitive holdings, such as flexible fixed income and floating-rate investments would also benefit as compared with core bond holdings if the global economy were to “reflate.”

This has been an extraordinarily long U.S. economic and market cycle. But we firmly believe it is still a cycle, so our patience and our emphasis on fundamental valuation will eventually be well-rewarded again, as it has throughout our history.

As always, The Gardner Group appreciates the trust you place in us, and we continue to work hard each day to earn it. If you have any further questions, please call to set-up a meeting at your earliest convenience.

Best regards,

The Gardner Group

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