Q3 Investment Meeting Summary

We held our Q3 investment strategy meeting on June 27, 2018. At our meeting we were fortunate to have a prominent local bond portfolio manager, Dean Amundson, join us. Dean’s knowledge and experience provided us with extremely helpful insights into the current bond market.

One concern that has increased within the bond area is the flattening of the term structure of interest rates (also known as the “yield curve”) which has been occurring as the Federal Reserve raises its short-term inter-bank lending rate (the Fed funds rate). The concern is that if the Fed pushes this rate much above the yield on the 5 or 10 year Treasury note (now at 2.53% and 2.85%, respectively), it could create what is known as an inverted yield curve. An inverted yield curve has historically been associated with or preceded the last seven U.S. recessions, so a flattening yield curve raises alarm bells among stock investors.

We think the concerns over the flattening of the curve may be premature. There are several reasons for our thinking; 1) we think the Fed will be very reluctant to cause a yield curve inversion; 2) over time, higher growth rates and inflation expectations should result in some increase in long-term bond yields; 3) we believe the economy can function normally even if the yield curve remains flattish (but not inverted), i.e., a flattish yield curve should not necessarily constrain access to capital or shut down bank lending.

Given the fixed income background, we think equities can still do well as long as inflation remains moderate, which we expect, and corporate cash flow growth remains strong, which we also expect. One concern is that equity valuations may have peaked (the “as good as it gets” argument). We think there is room for further improvement in valuation based on what we believe will be 1) a longer-than-expected economic cycle thereby 2) supporting a sustained higher level of corporate cash flows. We expect stronger sustained corporate cash flows should result in rising dividends and share buy-backs, which increase the attractiveness of stocks.

With respect to changes in our investment models (and your holdings), we slightly reduced our allocation to equities primarily through moving to a slight underweight in international stocks from a previous overweight position. Within both U.S. and international equities, we continue to maintain a relatively balanced allocation to both value and growth. We continue to maintain targeted sector investments in three areas:  financial (XLF), health care (IHI), and the U.S. housing sector (ITB). We believe all three sectors still offer attractive growth potential. Within bonds, we continue to maintain our lowest possible allocation to long bonds and continue an overweight in short-maturity bonds as we believe this sector should actually benefit as short-term rates rise. Within intermediate bonds, we added a position in shorter-maturity floating rate bonds in order to further reduce overall duration of your bond holdings and thereby help to reduce portfolio volatility.

Have a happy and safe 4^th of July holiday !

Robert E. Toomey, CFA/CFP

Vice President, Research