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Investment Letter

1st Quarter 2019

After narrowly escaping bear market territory in 2018, the decade long expansion in stocks rebounded to continue its resilient and historic run.  During the first three months of 2019, positive momentum broadened; economic fundamentals remained solid; the Federal Reserve pivoted monetary policy to a “patient” approach; trade negotiations with China progressed; recession fears abated; and investors enjoyed double digit gains in equities.  A strong start to the year!

While cash and bonds continued to be sources of capital preservation, the broad-based advancement in domestic and international equities drove investment performance for the 1stQuarter.  The Dow Jones Industrial Average (DJIA) finished at 25,928.68 with a total return of 11.81%, and the S&P 500 Index ended at 2,834.40 with a total return of 13.65%.  Despite the significant improvement over the previous quarter, the DJIA and the S&P 500 Index remained below the September 2018 all-time closing highs.


The table below recaps the performance of major indices:

Asset Class

Index

1st Qtr. 2019 Total Return

Cash

BofA/ML Three-Month U.S. Treasury

0.60%

U.S. Bonds

Barclays Intermediate-Term Treasury

1.59%

U.S. Large Co. Stocks

S&P 500 Total Return

13.65%

U.S. Small Co. Stocks

Russell 2000 Total Return

14.58%

International Stocks

MSCI EAFE (net div.)

9.98%

Real Estate

DJ Select Real Estate Securities Total Return

15.72%

                                Source: Morningstar

Economic fundamentals were solid again.  Strong job growth, low unemployment, low inflation, higher labor force participation, positive corporate earnings, healthy household balance sheets, and steady consumer spending continued to support the current expansion.

See the economic indicators below for additional information.  

 

GDP

2.2% Growth (annual rate) – 4th Quarter 2018

 
 

Inflation

2.1% CPI (less food and energy) and 1.5% CPI (all items) over last 12-months ending January

 
 

Interest rates

No rate increase during the 1st Quarter 2019.Federal Funds Rate range = 2.25 – 2.50%

 
 

Jobs

Unemployment at 3.8%; 196,000 non-farm payroll jobs added in March; Labor force participation rate 63.0%; Notable job gains occurred in health care and in professional and technical services.

 
 

Manufacturing

Manufacturing activity continued to expand, and the overall economy grew for the 119th consecutive month. The March ISM Manufacturing Index registered at 55.3%, an increase of 1.1% from February reading. Business strength expanded and supported by gains in new orders and employment.

 
 

Business Spending

Private non-residential investment continued to trend upward; New durable goods orders decreased 1.6% in February after increases over three consecutive months.

 
 

Corporate Profits

4th Quarter 2018 - U.S. corporate profits decreased slightly by 0.4%. S&P 500 Earnings per share = $35.03

 
 

Housing

February data - New home sales increased 4.9%; Existing home sales up 11.8%; Median sales price of existing homes rose 3.6%; Housing starts decreased 8.7%; Building permits fell 1.6%; MBA fixed 30-yr mortgage rates = 4.36% ending 03/29/2019

 
 

Consumer Spending

Disposable income remained strong; Consumer confidence declined in March after an increase in February; Retail and food services sales decreased from previous month; Total vehicle sales increased after a two-month decline; Personal durable and nondurable spending increased; Savings rate = 7.5%.

 
 

Energy

Oil price (West Texas Intermediate) = $60.19/bbl – 03/29/2019; Gas price (U.S. average regular unleaded) = $2.69/gal – 04/01/2019

 

The March 2019 Beige Book report released by the Federal Open Market Committee (FOMC) stated overall economic activity continued to expand across most districts. The report noted the government shutdown and harsh winter conditions led to some slower economic activity in retail, auto sales, tourism, real estate, restaurants, manufacturing, and staffing services.   The report also indicated the following: mixed consumer spending conditions; steady residential construction; lower residential home sales; weak agriculture conditions; mixed energy activity; strong employment conditions, tight labor markets; boost in wages for both low and high skilled positions; modest-to-moderate pace price increases.[1]

The FOMC’s March meeting revealed a significant shift in monetary policy.  Based on economic conditions, the committee decided to hit the pause button and maintain the current range for the federal funds rate after raising rates four times in 2018.  The decision signaled a pivot by the Fed to a “patient” or conservative approach toward rate adjustments.  While the committee expects favorable economic conditions to continue, they also recognized some uncertainties related to global economic and financial developments.  They emphasized future adjustments will continue to be data dependent, and they have a plan to stay flexible, shift policy to promote their statutory goals of maximum employment and price stability, and use all tools in their toolbox to support the economy and keep the expansion on track.  Early this year, Federal Reserve Chair Jerome Powell was part of a discussion group with former Chair Janet Yellen and former Chair Ben Bernanke on economic policy.  An interesting point was made that might provide some positive perspective on the current economic situation. They all agreed that economic expansions do not die because of old age.  They die due to financial imbalances and because the Fed acts to control inflation.  If you consider the low inflation dynamics and the near absence of significant financial imbalances, it seems the current economic expansion still has some room to run.

It has been close to three years (June 2016) since the United Kingdom’s (UK) Brexit referendum, and the original exit deadline of March 29, 2019 passed without a successfully negotiated deal.  A brief April extension was granted by the European Union (EU), but British parliament approval of a deal failed again.  To dodge a no-deal Brexit, EU leaders responded to the political disaster by forcing a “flextension” (flexible extension) that delays the departure date up to October 31, 2019.   Obviously, the additional time for UK leaders to negotiate and approve a strategy is necessary, but now the looming issue is the European Parliament elections.  If an exit agreement is not reached by May 23, Britain’s participation in the upcoming election process will be required.  That outcome is a situation both sides want to avoid due to the planned redistribution of UK parliamentary seats to other EU states.  At this point, it is likely the dysfunction will continue, and the European Parliament elections will proceed with the UK as a full EU member.

Global trade tensions and tighter financial conditions contributed to sluggish international growth much of last year, but 2019 has the potential to be different.  Central banks responded to tight financial conditions by pumping the brakes on their policy-tightening efforts, and trade negotiations between the U.S. and China improved dramatically.  Despite signs of slowing global growth, equities rallied in Europe, Japan, and China during the quarter.  We anticipate the switch to more supportive monetary policies and reduced trade tensions will yield positive results for global growth as the year progresses.

The calendar might signal a new year, but our domestic economic outlook is still optimistic.  Slow and steady growth, reduced interest rate pressures, low inflation expectations, and supportive fundamentals should persist in 2019.  We are concerned over the recent increase in oil prices.  The reduction in global output and sanctions on Iranian exports seem to be the root cause of the price correction.  While we expect some fluctuations, supply imbalances and prices should stabilize.  The Federal Reserve’s change in policy most likely means no interest rate increases this year.  Future economic data might reverse the committee’s stance, but for now, the “patient” approach will be the Fed’s new status quo.

Our 2019 international outlook is a combination of cautionary and optimistic.  Overall, we expect economic conditions to improve.  Trade negotiations between the U.S. and China are progressing, international equity valuations are attractive, monetary policy is supportive, and economic reforms are ongoing.  Our biggest international concern right now is the Brexit fiasco.  The inability of UK leaders to come up with a workable solution is alarming considering the amount of time provided.  At some point, the EU will finally say enough to the failed negotiations and accept the no-deal Brexit as a realistic outcome.  Let’s hope the impasse can be solved before the October deadline.

We are mindful of the potential risks to the domestic and international economies.  Specifically, slower growth potential, international trade, global monetary policy, political instability, Brexit negotiations, immigration, currency volatility, energy price shocks, extreme weather events, natural disasters, cyberattacks, terrorism, and escalating geopolitical tensions are issues that could impact economic and financial prosperity.  As always, we remain watchful!

As I have often stated, our investment philosophy remains based on the fundamentals.  We believe it is time---not timing---that matters most.   History shows the successful long-term investor is patient, weathers market swings, and adheres to a disciplined investment process that includes a diversified asset allocation strategy based upon a tolerance for risk and need for return.

Over the course of a lifetime, financial goals and objectives change and evolve.  A financial check-up can help evaluate your financial health, highlight adjustments needed, and develop and implement a plan for success.  If you would like to discuss changes to your financial situation, schedule a meeting, or have any questions, please contact our office.

In closing, I want to thank you for the opportunity of working with you and for your continued confidence and trust. 

With kindest personal regards, I am

Very truly yours,

WILLIAM HOWARD & CO. FINANCIAL ADVISORS, INC.

 



[1]Source: Federal Reserve System, Monetary Policy Beige Book Report, March 6, 2019. https://www.federalreserve.gov/monetarypolicy/files/BeigeBook_20190306.pdf

 

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