To Our Valued Clients,
After a couple of months hovering over the policy pause button, the Federal Reserve officially suspended interest rate hikes. The Fed’s estimates for future interest rate hikes—the closely watched “dot plot”—has shifted to indicate zero interest rate hikes in 2019, down from two estimated in December’s dot plot projections. We have experienced a very large and quick shift in the Fed’s stance on monetary policy. Since the market volatility in the fourth quarter of 2018, the Fed has struck a much more dovish tone. The Fed has also indicated a likely slowdown to its quantitative tightening program, also known as balance sheet normalization. Equity markets have cheered this change in Fed policy language as the S&P 500 returned over 13% in the first quarter, marking its best first quarter performance in a decade. Yields have fallen, and credit spreads—a measure of the premium investors demand to take credit risk—have tightened. Overall, the Fed has played a large role in calming markets in early 2019, but political challenges and economic data still represent uncertainty. Thus, we continue to have a cautious stance for investors as we move into the second quarter of the year.
In late March, and for the first time since 2007, the Federal Funds Target Rate moved above the 10-year US Treasury rate, also known as an inverted yield curve. This has a lot of investors worried because an inverted yield curve has historically been an indicator of an impending recession—but not always. A recession is generally defined as two consecutive quarters of negative GDP growth, economic decline with a reduction in trade and industry activity. Recent economic data and indicators argue we are far from these conditions with domestic real GDP still growing above 2%. Additionally, we’ve experienced a more dovish Fed, financial conditions rebounding since the December rout, China aggressively stimulating its economy once again, and US household finances boosting by accelerated incomes and job and wage gains.
Although we are still growing, we do continue to see signs of a late-cycle economic slowdown in the US. With an accommodative shift in Fed policy as an alibi for growth, there are alternatively several key catalysts responsible for slowing domestic growth. One of the most obvious is fading tax-cut effects. Consumer spending accounts for two-thirds of demand in the US economy and the single biggest driver of growth in real consumer spending is real after-tax income. The growth rate for real after-tax income has faded since a surge in early 2018 associated with the impact of US tax reform. Another reason for slowing growth is undoubtedly trade tensions. Continued trade disputes appear to be contributing to a slowdown in global economic activity and this has negatively affected US exports. However, it is important to distinguish this as a slowing US economy, not a stalling one.
Shifting our eyes to Europe, at the time of writing, it is becoming increasingly likely that a “no deal” Brexit could occur in the near-term. To date, the British Parliament has already rejected Theresa May’s withdrawal agreement three times. Michael Barnier, the European Union’s Chief Brexit Negotiator, warned that Britain may be forced to leave the bloc without an agreement, if May’s proposal cannot gain traction. Put simply, this means Britain leaves the EU without economic and trade arrangements in place, with no transition period to enable businesses and people to prepare. Under this scenario, UK trade with the EU would immediately be governed by World Trade Organization rules. Regardless, Britain would have to return to talks with Brussels so the bloc could then negotiate a free-trade agreement with Britain. There is still a chance for Britain to gain an extension, likely through a general election or another referendum. However, a long extension has both political and economic costs for both sides, especially if the back-and-forth bickering within the British Parliament continues. We will be keeping a close watch on these developments as we attempt to dampen downside risk.
Our team sees a number of positives as we move forward in 2019, including a more accommodative Federal Reserve, healthy consumer spending, and the potential for progress in the US – China trade talks. However, due to global economic concerns and slower earnings growth, we remain cautious. Under these conditions, we are dedicated to staying diligent and prudent in our decision-making, continuing to have a diversified approach to investment management and acting as a fiduciary for our clients.
As we head into the second quarter of 2019, we wish you and your families a happy and prosperous spring season. We thank you for your ongoing trust and confidence, and hope we can continue to help you discover The Next Piece – to Your Peace of Mind.™
Josh Williford, MSF
Director, Empowered Investor
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