Investment Review and Outlook – October 2019
Setting the Stage: Surprise and Humility
Politics continues to surprise us. We saw that with the last U.S. presidential election, and we continue to see it with Brexit, the trade war, and the current impeachment proceedings. Who knows what the future holds?
This unpredictability parallels an investing landscape that is similarly unimagined. We recently set a record low yield on the 30-year Treasury bond, and there is a serious possibility of negative interest rates migrating to the United States. At the same time, some stock indexes have touched record highs and we can no longer say with confidence that moving out of stocks into bonds will reduce portfolio risk. No one predicted this situation and no one can say with confidence which way financial markets turn from here.
Importantly, Daintree portfolios remain globally diversified across asset classes to help achieve strong risk-adjusted returns. This posture remains prudent and humility cautions us from overconfident or excessive portfolio changes in any direction.
Markets and Economy
Economic data also feels more uncertain. Consumer spending, a major component of economic growth, showed continued strength (though marginally less than last quarter). Conversely, manufacturing data showed growing weakness, with factory activity contracting for the second consecutive month in September and falling to a 10-year low. The Federal Reserve seems to be doing its best to address this division, cutting interest rates twice during the quarter. By the Fed’s own admission, these rate moves were preemptive and hopefully preventive.
Overall, the economy is still strong, but the outlook has diminished. As an example of the mixed data, the graph below shows a disconnect between hard and soft data. While the hard data (empirical reports such as GDP growth) tended to beat forecasts, the soft data (anecdotal observations such as business confidence) came in considerably lower.
During the third quarter, we saw the following:
- 10-Year U.S. Treasury yields fell from 2.0% to 1.7%, leading to core bond returns of over 1%;
- Global stocks (as measured by the MSCI ACWI benchmark) posted a flat return;
- S. stocks experienced an upswing in volatility, particularly in August (11 of 22 trading days with greater than a 1% move) and September; and
- Despite all the daily ups and downs, globally diversified portfolios delivered relatively flat returns.
Going forward, we remain cautiously optimistic about future returns. Even with the mixed economic data, the U.S. seems fundamentally healthy with low unemployment, low inflation, and healthy consumer confidence. While the rest of the world looks shakier, we believe global central banks will help support markets. We also believe that a resolution to the trade war, which looks more probable in recent days, would lead to an immediate amelioration of many economic headwinds. Our biggest concern is that investors are looking for a reason to worry as they believe a recession is overdue. At a certain point, worry feeds off itself and may become a self-fulfilling prophecy. We do not believe we are there yet, but we admit we cannot predict the timing.