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Investment Commentary: September 30, 2019

There are more than a few reasons to remain bullish on the economy and stocks in general, but the fact is the economy is slowing, and uncertainty is rising. We fear without a positive development or catalyst—namely within trade—the slowdown could turn what has been a very positive picture in employment and consumer behavior.

Donald Trump’s impeachment developments were not even the most negative headlines, market wise, during the quarter. Discouraging news was plenty. The Federal Reserve bowed to pressure and lowered interest rates again, furthering its modern‐day role as an unlimited source of stimulus, even if that stimulus empowers the poor fiscal management that caused the need for help in the first place. The Fed has also had to intervene in the short‐term bank‐to‐bank “repo” or “repurchase agreement” market with hundreds of billions of dollars as banks suddenly became unwilling or unable to lend even overnight and with quality collateral.1 We haven’t seen this since the financial crisis over 10 years ago.

Low interest rates have persisted globally, with a growing presence of negative‐yielding bonds. Latest headlines count some $15 trillion in negative‐yielding bonds today, up from $6 trillion a year ago. Inflation expectations have also fallen: the difference between Treasury rates and inflation‐protected Treasurys, or “TIPS”, imply the market thinks inflation (as measured by CPI) will average just 1.5% annually over the next 10 years and 1.6% over the next 30 years. Many market participants doubt central banks will ever be able to manufacture inflation again, even with indefinite money‐printing.

Geopolitics have worsened in many ways, from drone attacks in Saudi Arabia that temporarily cut 50% of its oil supply (and 5% of the world’s); to the U.S.’s souring trade with China, Europe, Canada, and Mexico; to new scandals in Britain and uncertainty regarding Brexit; to uprisings in Hong Kong; and increased nationalism and provocation from China, North Korea, Iran, and, yes, the U.S.

Some rational behavior may have finally entered Silicon Valley, where seemingly unlimited capital and speculation had driven up values of one tech “unicorn” after another. WeWork, the money‐losing shared office space provider that recently raised venture capital funding at a $47 billion valuation, pulled its IPO plans last week after indications showed the public market would only value WeWork at $12 billion or less. Post‐IPO drops in darlings Uber, Slack Technologies, and Peloton are more signals of waning euphoria.

1 Repos are how banks get large amounts of cash overnight. In a repo transaction, a borrower gets cash from another bank by selling high quality assets (like Treasurys) that it pledges to repurchase shortly thereafter and at a slight markup. This market is huge: it is said over $1 trillion of repos are done daily with Treasurys as collateral. The interest rate assessed is largely influenced by Federal Reserve policy, but in times of stress, the rates bank charges can spike. Instead of the usual 2.00‐2.25% annual rate repos have seen lately, some repos have priced over 5% or higher. The Fed has since stepped with money to keep the interest rate down

Last quarter we warned against market and news “noise.” But there also seems to be a higher stream of relevant facts and signals—so much so it is hard to complete careful, thoughtful analysis, because just as soon as you start, more chunks of game‐changing information comes in (and much noise, too). A new policy is announced, a new scandal tilts the odds of an upcoming election, something is attacked and blown up, Trump tests (or defies) constitutional limits…back at square one.

Someone once said that in any kind of strategic endeavor, one must start with facts, which help form thoughts, which lastly form feelings. In the internet age, we are all empowered and pushed to do the opposite: Find the thoughts that validate our feelings and then the facts to support our thoughts (and deflect all disconfirming evidence). Sadly, this is more the way things are done and the cause of numerous cognitive biases and mistakes, as well as a path to deception. The bottom line is, we should be spending more time curating and validating facts, which should support thoughtfulness and humility—two things we think must be increasingly valuable for investors going forward.

Pricing in the election

Trump’s behavior and impeachment possibility hasn’t helped him with trade and the economy, and the markets are taking note. Polls and prediction markets (like where wagers are made on outcomes) show Elizabeth Warren has now surged well ahead of Joe Biden. They also show Trump is now an underdog in the general election.

We think the markets could start discounting a Warren presidency if they are not already. If history repeats, markets—especially the stock market—will be unambiguous in how it anticipates a future of higher taxes, regulation, and a White House more combative to big business. Not that Trump hasn’t inflicted market pain. Volatility has risen, and the stock market is virtually unchanged over the past 21 months.

Client portfolios remain defensive and diversified. More defense could be employed—but so could more offense. Though we have focused largely on the negatives, the bull isn’t dead yet. The China trade negotiations next week are another opportunity to stem the direction of the trade war. We also think positive surprises may come as Trump realizes he needs a healthy economy and market in an election season, or the Fed errors on over‐stimulus. It is not time to give up on stocks just yet.

About the Author

Neil Rose, CFA
President & Chief Investment Officer




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