A Message From Our President:
Q1 2019 Market Update

Happy New Year to you and your loved ones.

Despite the volatile market we hope you have enjoyed a time of rest and relaxation. It is times like these that test the most stalwart of investors. As you have most certainly noticed, this last quarter was a tough one for investors.

Many have observed that this has been one of the most “unloved” bull markets because of the persistent doubt and lack of retail investor participation in the market. Numerous investors have been nervous all the way through and equity markets have experienced a number of corrections along the way. I believe the severity of the 2008-09 decline and the lingering effects of that recession had a profound psychological effect on investors and kept them looking over their shoulder fearfully. But through all that nervousness the economy made progress and stocks inevitably followed suit.

The economy is still, despite worries of all sorts, moving forward. This last market decline brought us within a whisker of having to declare the end of the bull market and the beginning of a bear market (declines of 20% are generally the yardstick) but, at least as we write this, we’ve managed to hold off this particular distinctive event for some future time.

Our analysis anticipates that the economy will grow in the first half of next year and then experience a mild recession. It remains to be seen how the Federal Reserve will handle interests rates this year. If they continue to raise rates we may see a slowdown more quickly. If they hold off on interest rate increases this may delay a slowdown and provide a boost to stocks. We anticipate that more volatility is ahead. We’ll continue to focus on fundamentals.

“Fundamentals” are the sorts of things we wished all investors paid more attention to. Corporate earnings growth, valuation measures, leading and coincident economic indicators and the growth in the economy are, primarily, the things that we believe move markets over the long term.

Multiple data points such as US Industrial Production and GDP tell us that the economy is still growing and, just as importantly, that it is likely to continue to do so in the first half of 2019. In our assessment, Folks are working, unemployment is at historical lows, businesses are firmly in the black and earnings are expected to grow further, just not as quickly perhaps as they did in 2017 and 2018.

So why was (seemingly) everyone selling? And why have stock and commodity prices fallen? The short answer, in our opinion, is that markets are like this over the short term. Over shorter periods markets reflect the mood of the moment from day to day and month to month. The “cause du jour” this time is more nuanced but the central issue is, as always, “uncertainty”. Companies surprised investors in October with lower projections of future growth and markets sold off. The recent tariff regimen and fears of resulting trade wars has also spawned uncertainty and, as tends to happen, the uncertainty has multiplied with worries about the price of oil, and what the Fed will do with interest rates.

Longer-term, however, we believe markets are always about the fundamentals. While these declines have created better valuations we remain cautious and expect to become more defensive in our portfolio allocations.

We will take a couple of pages to give you a summary of how the major asset classes in your portfolio performed and what we anticipate going forward. Of course, this discussion of asset classes should be viewed through your personal asset allocation and risk tolerance.

U.S. Bonds

Fixed income markets were challenged from several fronts in 2018. Short term interest rates have risen, pushed higher by the Federal Reserve in a few different ways. Rising rates typically result in a more difficult environment for existing traditional fixed rate bonds; results however, were mixed this year. While long-term rates also increased they did not move as quickly as some had expected due to modest expectations for inflation. The net result was a flattish total return for broad bond markets for the year.

Throughout the year we maintained exposure to floating rate bonds with their low sensitivity to interest rate increases, maintained exposure to high yield municipal bonds. These moves helped boost returns.

Foreign Bonds

Foreign bond returns were mixed as a strengthening U.S. dollar during 2018 acted as a general headwind for international investments of all types—especially fixed income, where absolute rates of return tend to be lower to begin with.

While lackluster performance in this asset class can be attributed in one part to currency fluctuations, concerns over global growth and the increasingly charged U.S.-China tariff spat, which carried investor worries toward emerging markets, also contributed. Our allocation to an Foreign Bond fund that is hedged to the U.S. dollar helped us outperform the category average and yield positive returns.

U.S. Stocks

U.S. stocks experienced substantially more volatility than they had the prior year, where every month had ended with a positive total return—a historical oddity. Instead, 2018 featured multiple -10% price corrections and substantially more uncertain sentiment. While 2017 was a very strong year for stock returns 2018 turned decidedly negative with the much watched S&P 500 index dropping 6.2% versus a 21.8% gain for 2017 (as reported by Standard & Poor’s).

We tilted portfolios towards high-quality, active managers to help portfolios handle increased volatility. While all stocks have suffered during the last several months of the year these managers were able to reduce volatility in the equity portion of your portfolio.

Foreign Stocks

In developed markets, slower growth in Europe and Japan as well as a strong U.S. dollar held returns below those of U.S. equities. On the positive side, historically, such performance divergences between domestic and foreign equities over time have often tended to normalize and eventually reverse, with foreign stocks currently in the position of holding the advantage of far more attractive valuations.

Our allocations to active managers modestly helped returns over the past year in this category.

Real Estate

This sector is especially sensitive to interest rates and the Fed’s rate increases had a dampening effect on the portion of your portfolio invested in real estate issues here in the US.

Commodities

Commodities lost ground in 2018, with the bulk of the asset class’ volatility stemming from extreme changes in the price of crude oil during the year. Following double-digit gains early, due to rising demand prospects and cuts in production by several nations, prices reached multi-year highs. While higher prices are challenging for consumers, investors in the commodity asset class benefit from such conditions. Later in the year, however, as production ended up higher than expected, oil prices plummeted.

Managed Futures

Managed futures benefit from strong positive and negative trends in the market as they trade these trends over short and medium time horizons. This provides a unique diversification benefit during times of volatility because they can rise with strong markets or with highly negative markets. Our Managed Futures allocations produced positive returns in the fourth quarter.

Outlook

My study of stock of market history shows that markets don’t rise uninterrupted forever and particular market declines are to be expected. More surprising had been the long period with significant less volatility. Market corrections of various sizes historically happen quite frequently and we were likely due for a period of increased uncertainty and associated market decline.

Looking at the fundamentals we see attractive market valuations after the last several months of selling. The economy should continue to grow in the early part of 2019 and we anticipate a mild slowdown in economic growth in the later half of the year. It is likely that we will continue to have some jitters around the continuing trade tariffs and folks will hang on the news out of the Fed in regards to interest rates.

If we continue to see the sorts of fundamentals many economists project for the early part of 2019 we could very well see markets rise. We remain cautious on the economy for the latter half of the year and will position portfolios accordingly.

We wish the very best for you and your family in 2019, and we want to thank you for your trust in us and for your business. It’s an honor to serve you.