Mid-Quarter Commentary

“Don’t be fooled by a low scoring game. The past twelve months have included a lot of action and shifts in policy that impacted the markets.”

Partners Kate Campbell King, CFP® and Brian Kozel, CFP® sat down to discuss the current state of the financial markets and the firm’s approach to managing client portfolios. Listen to their discussion to find out more, or read the transcript of their conversation below.

 

Q3 2019 Mid-Quarter Commentary

Hello! Thank you for joining us for the North Berkeley Investment Partners third-quarter conference call. I’m Brian Kozel partner and lead advisor at our firm and I’m joined on today’s call by one of our founding partners and current chief investment officer, Kate Campbell King.

On today’s call, we’re going to recap what’s been driving the markets recently, share our perspective and what adjustments we’re making, and review some of the questions that we’ve heard from clients over the past quarter.

If you’d like to have a conversation about your specific portfolio please contact your advisor. We look forward to talking with you. With that let’s recap the markets.

Fans of soccer or baseball know that a headline score of 1 to nothing often doesn’t tell the full story of excitement and tension that took place throughout the game. That has been the case with the stock market over the past year. As of August 14th, the S&P 500 was near the same level as one year prior but don’t be fooled by a low-scoring game, the past 12 months have included a lot of action and shifts in policy that have impacted the markets.

Two key factors have driven much of this action: interest rates and trade policy.

Before we explore and explain those topics a bit more, let’s review the numbers through Wednesday, August 14th.

The S&P 500 is up by 14 points, 8 percent so far this year but only 2% over the past 12 months. When we include the decline at the end of last year, international stocks as measured by the MSCI EAFE index are off more than 8 percent in 2019 but have actually declined by 2 and a half percent when we look at the past 12 months. Two standout performers this year have been real estate and gold, both of which offer some diversification from the equity markets. Gold has increased by 17 percent in 2019, often an indicator of concern in the markets. And real estate has gained 21 percent this year benefiting from lowering interest rates.

Lastly, the U.S. bond market, which we’ll talk about more in a moment, has returned eight and a half percent in 2019 and a steady nine percent over the past twelve months.

Coming back to our two themes of interest rates and trade policy, both of which we highlighted earlier this year on our January call.

We’ll start with trade policy and specifically tensions between the US and China. This has landed in the headlines many times as a juicy political narrative but it has had a real impact on the economy and our outlook for markets and portfolios. Hasn’t this been going on for a while you may ask? The answer is yes.

The current arc of trade talks and tariffs started back in April of 2017 and despite meetings, posturing, and promises, a deal has still not been reached more than two years later with many analysts increasingly speculating the one won’t be reached until after the next presidential election. The increasing number of tariffs which are simply taxes on imported goods serve the explicit purpose of slowing down global trade.

The effect is that many large companies have lower expectations for future growth and sales with this being mentioned explicitly on earnings calls from companies such as Coca-Cola, General Motors, and Caterpillar. In fact, more than 80 percent of S&P 500 companies slashed their profit expectations leading up to the current earnings season. Wall Street followed suit reducing company earnings projections at the fastest pace in nearly three years. If a deal is reached, the markets will likely respond positively but at this point, we’re unsure if that would be enough to reverse the trend of slowing global growth.

This brings us to interest rates. Between 2008 and 2017 the Fed kept its benchmark interest rate between zero and one percent despite the fact that the recession ended in June 2009. This represents years of historically low near-zero interest rates. Last year we actually saw four rate increases and by October the markets started panicking that rates were rising too quickly and political pressure was emphasizing that narrative. The market wanted to keep its access to easy cheap money.

Well, this ended up leading to a sharp decline in equity prices in the fourth quarter of last year. The Fed abruptly changed course and announced it would pause rate increases and ultimately decided to cut interest rates in July of this year back to two and a quarter percent. Still quite low from a historical standpoint. The market is expecting further rate cuts this year which is part of the reason we’ve seen the gains early in the year hold steady despite recent declines. Is that enough though?

The rise in gold prices and the recent inversion of the yield curve which caused the panic last week would suggest that investors remain concerned that the Fed and other central banks won’t be able to stave off recession much longer and when it does come they won’t have the same tools they’ve had in the past with interest rates already low and the Fed holding a massive balance sheet of assets from the last recession. It’s unclear how they will deal with a slowing economy and we’re committed to protecting our client assets and growing them intelligently.

With that, I’m going to ask Kate to provide some additional commentary.

Thanks, Brian. You mentioned that we’re committed to protecting our client assets and I’d like to make a comment about our long-term goal in many of our client portfolios. We are, in general, a cautious manager. We’re interested in making sure that our clients don’t lose too much when markets are readjusting on the downward side and we want our clients to have steady growth when markets are going up. Ultimately our clients are interested in maintaining their wealth as a secure resource for their lives going forward and we want to be sure that there are elements of every portfolio that create that security.

One of the most interesting pieces of the market to me this year has been the move in the gold price. It is not uncommon for the gold price to be moving up ahead of interest rates going down. It reflects a desire for more certainty. Many people want to know that their assets are going to be safe at a time when there’s volatility out there, and the kind of headlines that we’re continuing to get with trade policy are a classic circumstance that worries people, creates some actual negative impacts, and yet is completely beyond our control.

So the way we have the portfolio positioned is in order to take advantage of some of the protective elements of the portfolio but also to have some growth elements there. When it comes to the issue of a potential recession, we’ve been skirting around with inverted yield curve levels for over a year now and you know the pessimists say Oh a recession is coming and the optimist saying no, no we’re going to be okay, and besides the economists have predicted nine of the last five recessions so don’t let them scare you.

In the manufacturing sector, it is true that there are many economic data points indicating slowdown. However, manufacturing is only about 16 percent of the economy. The services portion of the economy is larger and in the technology space you know technology has now managed to import itself to just about every traditional economic sector and have an impact there. That impact is often more of a service-oriented impact than a manufacturing-oriented impact and I think that there are some possibilities for continued growth that we would not normally anticipate when we look back many, many decades at classic economic cycles.

Kate, you mentioned that the manufacturing sector is only 16 to 17 percent of the U.S. economy at the moment. One of the narratives and there is some truth in this is that a lot of that manufacturing that we’ve done previously has shifted overseas. China has been a big benefactor of that and we have this trade war we’re in the midst of at the moment. How do you think about that in relation to portfolios and strategy when you look at this tension between the manufacturing that’s been offshore, the services sector that’s still onshore, and the interplay between those.

So one of the interesting things about a slowdown in economic activity. As you said tariffs lead to a slowdown in activity because it makes the same goods, and in some cases services, but primarily goods, more expensive. In addition to that, if a company doesn’t want to pass on price increases to its customers it absorbs the costs itself and now its profits go down. And when your profits go down that means that your stock price goes down because investors are generally looking for a stream of profits that grows into the future. When we have that kind of a slowdown it should lead to an overall decline in the prices that stocks are selling for across all of the sectors that tariffs are affecting.

We’ve been saying for a long time that we think a pullback in stock prices would be a good thing. The reason for that is that when you have lower prices, there’s less downside risk. I’m not saying that bad news is good just because it can’t get much worse but the volatility and the sensitivity of stock prices and bond prices right now to various economic and market data points is at a very heightened sensitivity. It creates a lot of risk, creates more drama in headlines, and focuses everybody on the very short-term. What’s happening today, what happened yesterday, what’s going to happen next week.

We know that these investments are for the very long term (and we’re talking about financial investments inside of a portfolio) and the purpose to which most of our clients put this money, the investment they have in their lives of wanting to send their kids to college of wanting to be able to help their kids pay for weddings or start grandchildren on education whatever that might be. Those are the real investments that people want to be able to make and that’s the purpose of the portfolio is to maintain its value over time and to grow so that it can be used for those things.

Thanks, Kate. We will conclude our comments there we welcome any feedback on our mid-quarter commentary and look forward to our next conversation with you.