Friday, September 28, 2018

Research Director Monthly Commentary: September 2018


Q4 Investment Committee Meeting Review

 
We held our Q4-2018 investment committee meeting on September 27. The key take-aways from the meeting are:  1) we continue to have a positive view towards equities; 2) we took some steps to modestly de-risk our U.S. equity exposure; and 3) our stance towards fixed income holdings remains unchanged.

The macro context for equities continues to remain positive due to a strong U.S. economy and continued strong corporate profit growth. The U.S. economy is showing broad-based strength across virtually all sectors. Consumer and business confidence remains strong and is driving healthy spending in those sectors. Employment is strong. Manufacturing is healthy reflected in rising orders and production and strong corporate cash flows are getting recycled into the economy by way of increased hiring and capital spending. We believe this bodes well for continued economic expansion. While the trade tariff issue continues to be a concern, the quantifiable impact of tariffs on the economy are modest and very small in actual dollar terms relative to total U.S. trade volume.

With respect the Federal Reserve’s recent increase in the Fed funds rate, this was expected and does not alter our assessment of Fed policy which remains essentially unchanged. At this point, Fed policy continues to remain gradualist and accommodative to the financial markets. At some point this may change, but we believe it is a ways off, especially if inflation remains low to moderate. We expect there will be some increase in inflation over the next year but we believe it will remain modest, perhaps 2.2-2.5%, and certainly not 1970s-style inflation. Low inflation should allow the Fed to remain gradualist in its policy and thereby should not be overly disruptive to the financial markets, at least near term.

On a relative basis, we still believe U.S. equities remain the most attractive of the major developed markets and we therefore continue to overweight our U.S. equity exposure and underweight international. While the U.S. economy is clearly in the most stable condition of major world economies, of late emerging market economies have suffered due to uncertainties surrounding the trade tariff issue.  The Eurozone economies continue to plod along at modest 2% growth and we do not see much upside to Eurozone growth.

We have become somewhat more concerned of late about stock valuation. Valuation is “high” by a number of measures. While a high valuation does not imply an imminent decline or rollover in the market, we believe it is prudent, given our concern, to address valuation risk in your portfolios. A couple of the steps we are taking this quarter to mitigate valuation risk include: 1) increasing weightings toward value stocks; 2) adding a position in the U.S. telecom sector ETF (IYZ) which we believe offers lower valuation and reasonable risk/reward. Taken together we believe these actions place more of your equity investments into sectors that offer lower valuations and lower downside risk in the event of a market decline. Within commodities, we added an investment in the metals and mining sector (XME) as an inflation hedge. Overall, our equity exposure was reduced very slightly. There were no changes in our bond holdings nor were there any significant changes in weightings within the three fixed income sectors. We expect interest rates will continue to rise gradually and we therefore continue to maintain the lowest possible exposure to long bonds while keeping overall bond duration at the low end.

Robert Toomey, CFA, CFP
Vice President, Research
9/28/18

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