August 2021 | Equity Commentary

August 2021 | Equity Commentary

Published on September 8th, 2021

Market Overview

The S&P 500 index rose about 3% in August, marking its seventh consecutive monthly increase. Year to date through August, the index made 53 new all-time highs—the most recorded since 1964. Since the March 2020 lows, the S&P 500 has more than doubled1, charting a “v-shaped” recovery often characteristic of event-driven bear markets. Ten- and 30-year U.S. Treasury bond yields remained relatively unchanged in August, which appeared to complement decelerating inflationary pressures and a still-dovish Federal Reserve.

Stocks’ summer rally coincided with a robust earnings season. A Wall Street Journal analysis found that more than 75% of U.S. companies reported higher revenues in Q2 2021 than Q2 20192, which offers insight into corporations’ ability to resume pre-pandemic growth trends. FactSet data from mid-August showed that of the 91% of reporting S&P 500 companies, a staggering 87% of them had delivered positive earnings-per-share and revenue surprises for the quarter.3

The U.S. economy continues expanding, but we believe there are a few signs growth may be cooling slightly. In August, factories and service providers – as measured by the IHS Markit surveys of purchasing managers – saw activity dip. On the service-sector side, the purchasing managers index fell to an 8-month low of 55.2, while the manufacturing index sank to a 4-month low of 61.2.4 These declines are noteworthy, though it’s worth recalling readings above 50.0 signal expansion. The economy appears to be still growing, just at a slower pace.

The Federal Reserve held its annual Jackson Hole symposium virtually for the second consecutive year. As ever, investors parsed Chairman Jerome Powell’s speech for clues regarding when, and how quickly, the Federal Reserve may begin tapering bond purchases and/or raising interest rates. Though opinions vary among FOMC members, Chairman Powell continues to tilt dovish and appears committed to moving slowly. Many market participants continue to link tapering with rate increases, but Chairman Powell has attempted to disassociate the two. His statements suggest tapering need not directly signal an impending rate hike in 2022.

Chairman Powell also seems less concerned about a tight labor market driving inflationary wage pressure than some of his more hawkish counterparts, who cite employers’ ongoing challenges finding workers. Though the Federal Reserve has no parameters defining ‘full employment,’ Chairman Powell seems fixated on employment being ~6 million jobs below its February 2020 level, with stubborn levels of slack in the services sector. He sees a low likelihood of a persistent wage-price spiral.

The Federal Reserve remains similarly dovish on inflation as it believes Covid-related supply chain disruptions are driving relatively narrow price gains—a view supported by longer-term inflation expectations, which remain relatively moderate. Chairman Powell has clearly stated his belief it would be a mistake for the Federal Reserved to respond to what it views as temporary price fluctuations, which makes interest rate increases very unlikely in 2021.

On the political front, the House of Representatives inched closer to passing Democrats’ economic centerpieces before adjourning for its August recess. A 220-212 party-line vote approved a $3.5 trillion budget framework (the American Families Plan) and advanced the $1.0 trillion infrastructure bill. The Senate already passed the budget framework, allowing House and Senate Democrats to craft a budget without Republican involvement (budget reconciliation only requires simple majorities in both chambers).

In exchange for moderate Democrats’ support for the reconciliation bill, Speaker Pelosi has committed to a vote on the infrastructure bill by September 27. As ever, the devil will be in the details, many of which are still missing and will likely prompt sharp debate among the various factions in the Democratic Party. Further complicating the legislative schedule is the impending debt ceiling, which the U.S. government may reach in September or October. All told, increased spending—which seems likely under most legislative scenarios—should provide a modest fiscal tailwind in future quarters.

Surging Covid-19 (Delta variant) cases in the U.S. have shown signs of weighing on consumer sentiment. The Conference Board’s consumer confidence index fell from 125.1 in July to 113.8 in August, pulling the index back to February 2021’s level (before the vaccine was widely available). Consumer spending growth in July was up just 0.3% from June levels—a considerable deceleration from May to June’s 1.1% growth.5 Some states and businesses have responded to rising cases by reintroducing indoor mask mandates and/or requiring proof of vaccination, and event cancellations and delays are becoming more common. Several high-profile corporations have also delayed office reopening plans.

August offers a single data point for consumer sentiment, and it’s worth noting sentiment data tend to be backward-looking. It does not offer much insight into where the economy may be headed, particularly if Delta ebbs as quickly as it has in countries like India and the U.K. Fading pandemic risk could unleash some additional spending as consumers return to more normal economic activity. We believe the odds favor a peak in new cases over the next 3-6 weeks, although students returning to the classroom could also spur a rise in new cases.  Ongoing fiscal stimulus is also bolstering the economy in the near term, as child tax credit starting hitting accounts in July. Fiscal stimulus contributed to a 1.1% July increase in household income (according to the U.S. Commerce Department), marking the biggest jump since March 2021.  

Globally, rising cases—particularly in Southeast Asia—are disrupting production and prolonging supply chain issues. Malaysia, an important if underappreciated link in the semiconductor supply chain, has struggled with a recent surge in cases, prompting staff shortages and introducing yet another hiccup in semiconductor production. China’s economy is also showing signs of ongoing Covid-related strains: that country’s services sector purchasing managers index (PMI) contracted in August for the first time since February 2020, while manufacturing PMI barely eked out a positive reading (50.1), with the new orders sub-index modestly contracting (49.6).6

Finally, the geopolitical situation in Afghanistan reached a climax in late August with the full U.S. troop withdrawal. The market effect appeared negligible, despite the tragic loss of life. The tail risk in the U.S. revolves around domestic policy—e.g., if the Afghanistan unraveling were to disrupt the Biden administration’s pursuit of other economic policy objectives, like the aforementioned spending packages.







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July 2021 | Equity Commentary

July 2021 | Equity Commentary

Published on August 10th, 2021

Market Overview

U.S. stocks continued trending higher in July, with the S&P 500 ticking about 2.4% higher. Longer duration U.S. Treasury bond yields fell during the month, which may signal the market’s expectation for moderating growth and inflation in the second half of 2021. The Bureau of Economic Analysis reported the U.S. economy grew at an annualized pace of 6.5% (“advance” estimate) in the second quarter, which while strong, still fell below the  8+% consensus estimate. The Bureau also confirmed the 2020 pandemic-induced recession officially ended in April 2020, meaning the economic downturn lasted only two months. As it were, when the recession was officially declared in June 2020, it was already over. 

The U.S. economy is now back above its pre-pandemic size. Consumer spending persists as the lead driver of the expansion, with spending up 11.8%  in the three months ending June 30—the second-best performance since 1952.1 Business investment also rose 8%, adding 1.1%1 to the total GDP  number.  

Data suggests business spending growth could persist in the second half of the year. Corporate clients of J.P. Morgan and Bank of America have nearly $1 trillion (combined) in unused credit lines, and many have been asking the banks to increase them further. J.P. Morgan recently conducted a  survey of corporate clients and found 46% want to ramp-up capital spending later this year, with 38% indicating a desire to increase credit lines.2 

The drag on U.S. economic growth in the second quarter came from a combination of inventory drawdowns, which subtracted 1.1% from GDP,  rising imports, and a decrease in federal government spending.3 According to the Bureau of Economic Analysis, nondefense spending on intermediate goods and services fell the most, largely due to a drop-off in Paycheck Protection Program (PPP) loans. 

The Covid-19 Delta variant is spreading rapidly in the United States and in many countries abroad. Case studies of India and the United Kingdom suggest the Delta wave could last a few weeks and taper off, but this disease continues to be unpredictable even for the world’s foremost scientists.  With regards to equity markets, the central question is whether governments reinstate lockdowns in an effort to stem the spread. We believe that here in the U.S., the risk of another lockdown remains low. 

Vaccines are universally available to U.S. adults, which makes current risk far different than in previous stages of the pandemic. Mitigation measures, such as masking and social distancing, are also widely understood and can be carried out without shutting down major parts of the economy. Corporations, state and local governments, and the federal government, are also experimenting with mandates as a means to control risk,  while staying open. 

For example, General Motors, Ford Motor, and Stellantis (the maker of Jeep and Dodge), have reinstated mask mandates for all factory and office workers, regardless of vaccination status. Stanley Black & Decker has done the same. Facebook, Google, and even Tyson Foods have said they would require vaccinations for their entire U.S. workforce. Louisiana has introduced indoor mask mandates, while New York City will require people to show proof of vaccination for indoor activities like dining, gyms, and events with large groups. More examples exist across the economy,  but the bottom line is that as long as the vaccines remain highly effective at protecting against serious illness, there can be ways to address the ongoing crisis without shutting down. 

The widely-watched infrastructure bill passed a key hurdle in July. The bill must move through a very difficult amendment process in the Senate before moving over to the House, where it will likely be met with Democratic critics and mild support from Republicans. In other words, final passage is far from assured.  

Even so, it is worth summarizing key features of the proposed legislation, as winners and losers are often minted in big government spending  programs: 

• $110 billion for traditional infrastructure, i.e., repairing and improving roads and bridges 

• $39 billion to modernize public transit, including introduction of a zero-emission bus fleet 

• $66 billion for passenger freight and rail systems 

• $7.5 billion for a national network of electric vehicle charging stations 

• $17 billion for ports and $25 billion for airports 

• $65 billion expansion of broadband Internet access 

• $55 billion for clean drinking water 

• $73 billion in clean energy transmission 

Finally, the Labor Department reported a 5.4% (4.5% core) CPI increase in June from the previous year. The base effect still applies since the U.S.  economy was heavily restricted last summer, but when compared to June 2019 inflation still rose by a stout 3%. In his July testimony to Congress,  Federal Reserve Chairman Jerome Powell seemed less confident than usual: “This is a shock going through the system associated with reopening of the economy, and it has driven inflation well above 2%. And, of course, we’re not comfortable with that.”




Second Quarter 2021 | Fixed Income Commentary

Published on July 16th, 2021

Second Quarter 2021 | Fixed Income Commentary

Market Overview

Fixed income markets climbed higher throughout the second quarter as declining US Treasury yields supported valuations. Roosevelt’s Current Income Portfolio returned 1.7% gross, with corporate bond and preferred securities gaining by 1.4% and 3.0%, respectively. By comparison, the Bloomberg Barclays Intermediate Corporate Bond Index returned 1.7% and the ICE BofA Fixed Rate Preferred Securities Index returned 3.0%.

During the quarter, the Consumer Price Index surprised investors to the upside and rose by 4.2% in April. The largest advances were concentrated in areas most affected by the pandemic such as air fares, lodging and used car prices, which support the FOMC’s narrative that the building inflationary pressures are transitory. Moreover, retail sales and employment data have fallen short of expectations, spending on durable goods moderated, and housing starts declined sequentially, as rising input costs and labor shortages began to take hold. After rising during April and peaking in early May, lumber prices declined by month end.  Taken together, incoming data throughout the quarter may have softened inflationary concerns somewhat and caused 10Y US Breakeven Inflation levels, which are indicators of expectations for future inflation, to decline by 3 bps.

In June, the Federal Reserve sent a hawkish signal in the FOMC meeting by discussing the potential tapering of asset purchases sooner than previously expected and by updating dot plot expectations to reflect two 25 bp interest rate hikes in 2023. The unexpected shift from the Federal Reserve’s previous stance on “FAIT” (Flexible Average Inflation Targeting), whereby the FOMC would let the economy run hot with an inflation target above 2%, to average ~2% over time, put into question just how much the Federal Reserve is willing to let inflation go before taking steps to curtail economic growth. Expectations of an earlier lift-off by the Federal Reserve in raising interest rates, coupled with continued slowing consumer demand, mixed employment data, and concerns over new cases of the delta variant, have slightly dampened the economic growth outlook . As a result, 10Y US Real Yields have fallen by 24 bps and contributed to most of the decline in 10Y US Treasury yields as well as in the spread between 2Y and 10Y US Treasury yields, which fell by 27 bps and 23 bps, respectively.

Second Quarter 2021 decline 10Y US Treasury and 10Y US Real Yields:

Source: Bloomberg

Lower government yields, and a flatter overall yield curve, have led longer duration securities to outperform. Corporate bonds with maturities in the 5-10 year range gained by over 1% this quarter and recovered some of their losses from earlier in the year. In addition, retail, $25 par, predominantly fixed-rate coupon preferred securities gained by 3.3% during the quarter, while institutional, $1,000 par, fixed-to-floating rate coupon preferred securities saw gains of 2.5%.

The resulting flatter yield curve, however, has also made attractive reinvestment opportunities in fixed income markets harder to find, as there is less incentive to take on duration risk for only modestly higher yield compensation. Nevertheless, we continue to fund portfolios with attractive yields and a shorter duration than benchmark intermediate-term investment grade corporate bond and preferred securities markets. We also continue to favor high coupon, low duration, fixed-rate coupon preferred securities, in addition to fixed-to-floating rate coupon preferred securities, to diversify our interest rate risk exposure and protect against the potential for rates to go higher. Our goal to enhance yield and reduce risk is unchanged, and we believe the portfolio is defensively positioned to withstand potential volatility and earn reliable income regardless of the underlying economic environment, expectations for inflation or the path of interest rates in the future.

As of June 30, 2021

June 2021 | Equity Commentary

Published on July 13th, 2021

June 2021 | Equity Commentary

Market Overview

We believe the United States is very close to full reopening, with nearly all 50 states removing pandemic-related restrictions for vaccinated adults. Stocks may have largely priced in the economic rebound, but better-than-expected earnings and growth outcomes—combined with a still-dovish Federal Reserve and a retreat in longer-duration Treasury bond yields—continue providing upward support for equities. Approximately 80% of stocks in the S&P 500 Index are in an uptrend, underscoring the healthy breadth in the stock market. The S&P 500 added another 2.3% for the month, bringing year-to-date gains (through June 30) to 15.2%.

The U.S. economy appears to be humming. Consumers are largely driving the growth, armed with accumulated savings from the past year. According to the Bureau of Economic Analysis, pending volume on consumer goods is over 10% higher than pre-pandemic levels, and early data suggests consumers are now shifting their dollars to services. Spending on leisure and discretionary services (travel, restaurants, etc.) rose 0.7% from April to May, while spending on furniture and cars fell by 2.8% over the same period.

Business investment is also trending favorably, in our opinion. Data from the Federal Reserve Bank of St. Louis shows that nonresidential private fixed investment, which is a proxy for business investment, increased at a seasonally adjusted annual rate of 11.7% in Q1, following double-digit increases in Q3 and Q4 of last year. Following the “Great Recession” of 2008-09, businesses seemed more reluctant to invest in capital and equipment, and labor was cheap. In the current economic recovery/expansion, labor is tight and wages are rising, so it appears that businesses are opting to increase spending on computers, equipment, software, and other technology infrastructure in an effort to drive productivity. There is also apparently greater desire in the business community to build supply chain resiliency and to ‘on-shore’ more production, all of which is being helped along by historically cheap borrowing costs.

In the first six months of the year, the U.S. economy added about 3.3 million jobs, but is still 7.6 million jobs shy of the employment level attained prior to the pandemic. Perhaps unsurprisingly, new jobs at restaurants, hotels, stores, salons, and other in-person service industry roles accounted for nearly half of all payroll gains since the start of the year. Even though millions of Americans remain unemployed, the labor market is tight, which has created headaches for businesses while giving workers some leverage—according to ZipRecruiter, about 20% of all June job postings offered a bonus, up from 2% of jobs advertised in March. Wages are also being pressured higher.

In May, the median existing home price crossed $350,000 for the first time ever, marking a 23.6% jump from the previous year. In fact, it was only 11 months ago that the median existing home price topped $300,000 for the first time1, underscoring sharp price pressure as many urban workers migrate around the country and buy homes for remote work setups. Persistently low mortgage rates and a fairly drastic supply/demand imbalance (where demand far outweighs supply of homes) are also pushing home prices up. A 2021 report from the National Association of Realtors found that home construction over the last 20 years has fallen 5.5 million units short of historical trends. 

These are all key factors driving home prices higher, but the depth and breadth of housing demand may be best explained by demographics. A large share of workers under 40 (millennials) have jobs that allow hybrid/remote work, and many are first-time homebuyers. But there are also just a lot of millennials in America—according to the U.S. Census Bureau, the largest age cohort in 2020 was individuals between the ages of 25 and 35.

Oil prices have soared past $70 a barrel, approaching a six-year high and putting pressure on gas prices across the country. Demand has returned to the global economy and to the U.S. faster than supply has kept up. Last year, OPEC cut output by 9.7 million barrels a day, but they have only brought back about 4 million barrels since then. In OPEC’s June meeting, the United Arab Emirates (UAE) balked at an agreement to increase overall production by 400,000 barrels a day each month through late 2022, largely because the UAE wants much of that production for itself. OPEC data suggests the market needs an additional 2 million barrels a day by the end of the year. Without additional supply, oil prices could remain at elevated levels in the months ahead.

By the narrowest of margins, in June President Biden and a group of 10 centrist senators agreed to a roughly $1 trillion infrastructure package. According to a list distributed by the White House, the bipartisan spending bill includes agreement to the transportation-related items on Biden’s priority list, with new investments in the electrical grid, transit, roads, bridges, and other forms of infrastructure. The cost of the spending would be covered by “repurposing existing federal funds, public-private partnerships and revenue collected from enhanced enforcement at the Internal Revenue Service.” Within days, however, the deal’s passage was in jeopardy, as President Biden alluded to wanting the $1 trillion package to be accompanied by an anti-poverty bill and other parts of his $4 trillion American Jobs Plan. Republicans balked and Biden walked back his comments, reminding us how fragile any bipartisan agreement on spending will ultimately be. It is reported that Congress will be working towards a deal on this legislation in the coming weeks, prior to the August recess.

Market leadership started to shift over the last month or so. From the late last year through the middle of May, the so-called ‘reflation trade’ outperformed; cyclicals, value stocks, and the shares of many companies believed to benefit most from the reopening of the economy led the market—the Russell 1000 Value index rose +15% compared to just +2% for the Russell 1000 Growth index. But since then that trade has reversed, with growth stocks outperforming value stocks (+2%). This rotation in equity markets was commensurate with a rally in U.S. Treasury bonds, which saw the 10-year Treasury bond yield decline from around 1.7% to around 1.4%. This decline in Treasury yields marked a reversal from the sharp rise early in the year, and may be sending a signal about falling investor expectations for economic growth and inflation going forward. It is too early to tell how this story plays out, but equity market leadership could be choppy as we get more clues from the economic data about inflationary trends.

As of June 30, 2021

May 2021 | Equity Commentary

Published on June 2nd, 2021

May 2021 | Equity Commentary

Marketing Overview

U.S. equity markets moved slightly higher in May but rising inflation concerns led to more volatility during the month. However, there is little doubt about the momentum of corporate fundamentals heading into summer. As of the end of May, nearly all of the S&P 500 companies had reported Q1 2021 earnings, with 87% posting positive earnings-per-share (EPS) surprises. That is the highest percentage beating estimates since at least 2008. European equities produced better returns than U.S. equities in May, as daily vaccination rates in Europe passed the U.S. for the first time. The ‘rolling’ global economic reopening that started with China and moved to the U.S. is now approaching Europe, which we believe bodes well for global economic growth forecasts in the quarters ahead.

Inflation took center stage as a headline risk in May, driving elevated volatility in the middle of the month, before Federal Reserve governors shared their views that inflation was likely transitory, and these comments appeared to calm markets. U.S. consumer prices jumped in April by 4.2% from a year earlier, marking the biggest 12-month increase since 2008. To be fair, April 2020 was early in the pandemic, so the base effect (comparing last year to this year) is a big reason for the steep jump. The more telling data point, in our view, is the 0.9% increase in core inflation from March to April, the biggest rise in monthly inflation since 1981.

Many readers have likely noticed signs of inflation in the economy. The national average for a gallon of gas crossed $3 a gallon for the first time since November 2014, lumber prices have more than doubled in 2021 to date, and copper prices are over 30% higher. For the first time ever, the average price paid for a used car rose above $25,000.

The housing market has also seen pronounced price pressures. The S&P CoreLogic Case-Shiller National Home Price Index jumped 13.2% from March 2020 to March 2021, which is the highest annual rate of price growth since December 2005. The U.S. Commerce Department reported that the median price of a new home sold in April was $372,400, which marked a 20.1% increase over the last year. That’s the biggest annual surge in new home prices since 1988.

Supply and demand imbalances in the housing market may ultimately correct themselves. Data over the last few months indicates that lack of inventory and higher prices are causing home sales to cool off – existing home sales have declined for three straight months and fell 2.7% from March to April. The share of consumers who said they plan to buy a house also fell to its lowest level since 2013. The pandemic catalyzed many structural changes in business and the economy, and it may have also fueled a rapid wave of migration that could abate in the coming quarters and years.
The Federal Reserve and the financial media seem to be in a tug-of-war over the inflation narrative. The Federal Reserve has been leaning into the ‘inflation as transitory’ narrative while some in the financial media have been framing long-term inflationary issues as a foregone conclusion. Both sides offer valid arguments, but investors may be better served to sidestep the debate and simply keep an eye on the 10-year U.S. Treasury Breakeven Inflation rate. This measure has seen a significant rise over the last year, but stalled in May at around 2.4%. We would attribute the pause to the rate of increase in previous months, a softening of long-term inflation expectations, and strong continued demand for government securities.

The U.S. economy continues its rapid recovery, supported by the reversion to normalized pre-pandemic activity, monetary accommodation, and fiscal stimulus. A key metric in U.S. labor markets, initial unemployment claims, fell to a new pandemic low at the end of May. Claims came in just above 400,000, better than most economists estimates and confirming a steady downward trend. Initial jobless claims are now at their lowest levels since the pandemic’s onset. Consumer confidence also remains on a upward trend, and while it has yet to reach pre-pandemic levels, appears poised to do so perhaps later this year.

Internationally, Europe appears to be turning a corner on the pandemic, with 30% of adults now vaccinated compared to about 50% in the U.S. Europe reached a new milestone in May, however, surpassing the U.S. in daily doses administered. As the E.U. emerges from recession and joins the U.S. and China in its return to growth, we expect the global economy to gain momentum as the year progresses. Overall, while we continue to keep a watchful eye on the risks posed by rising interest rates and inflation, we still believe the most prudent course for equity market participants is to remain broadly invested to capture the benefits of global reopening.

As of May 31, 2021

The Great Inflation Debate

The Great Inflation Debate

Published on May 17th, 2021

The S&P 500 declined 4.0% from May 10 to May 12, the largest three-day selloff in five months. The Nasdaq composite declined 5.2% and the Russell 2000 index of small capitalization stocks declined 6.0%. We believe investor concerns about inflation sparked the pullback.

On May 12, the U.S. Bureau of Labor Statistics reported that its widely followed Consumer Price Index increased 4.2% in April as compared to the year ago period.1 The CPI increased 0.8% as compared to the prior month, seasonally adjusted. These price increases were higher than expected.2 They were also an acceleration from the growth rates reported in March. The annual increase was the largest in twelve years.

Investors had been bracing for higher inflation to show up the data. One reason is that prices in the year ago comparison period were depressed by the pandemic, a phenomenon known as the base effect. But growth in the April price index as compared to the prior month also accelerated, which cannot be attributable to the base effect.

Most observers believe that inflation is picking up in the U.S. The great debate is whether this increase is transitory. Investors and policymakers typically pay little attention to one-time changes in the price level. But a persistent inflationary environment can be pernicious. It can grow out of control if left unchecked, eroding both consumer purchasing power and corporate profitability. It could weigh on the U.S. dollar, reducing the allure of the U.S. capital markets for foreign investors. And if monetary or fiscal policy is tightened to address runaway inflation, it could choke off the economic recovery.

We divide the current drivers of inflation into three categories. The first is the post-pandemic economic reopening. In April, airline fares increased 9.6%, hotel room rates increased 8.1%, and car rental rates increased 82.2%.1 These were driven by the base effect as prices were depressed a year ago. We expect travel and similarly impacted service industries to increase supply and catch up with demand in the coming months, suggesting this category is likely a source of transitory inflation.

The second category is the knock-on effect of supply chain bottlenecks. Winter Storm Uri shut Gulf Coast chemical plants in February. The Suez Canal was blocked for six days in March, distorting global trade flows. A fire at a Japanese semiconductor plant in March exacerbated a pandemic-induced chip shortage. We believe events like these contributed to a 21.0% increase in used car prices in April, as supply chain constraints prevented automakers from sufficiently replenishing new vehicle inventories at dealers, increasing the value of used vehicles.1 While there is a litany of supply chain issues, we expect most to be resolved in the coming months, suggesting this is another source of transitory inflation.

The final category is labor cost inflation. We believe this is the area of greatest concern, because wage increases tend to be sticky, and increasing labor supply may be more challenging than other inputs to production. Recently there have been signs that labor supply has not kept up with demand. On May 11, the Bureau of Labor Statistics reported that U.S. job openings in March reached 8.1 million, a record level.3 This occurred despite surprisingly anemic nonfarm payroll additions of 266,000 in April, also reported by the BLS on May 7.4 The increase in average hourly earnings in April was a meager 0.3%, but that is because a pronounced mix shift toward lower-wage workers masked more rapid wage inflation within categories.4 The tight labor market may have manifest itself in the 3.6% increase in restaurant prices recorded in April, as labor is the largest expense item at most restaurants, and, unlike other reopening beneficiaries, this category did not see price compression in the year ago period.1,5

Several unusual factors are coming together to suppress labor supply. Fortunately, these may be addressed in the coming months. Some able workers have left the labor force due to fear of contracting or spreading infection. But additional vaccine distribution, the steady reduction in new Covid cases since mid-April, and the May 13 relaxation of guidelines by the Centers for Disease Control and Prevention may give these workers the confidence to return to employment.6 Others have left to care for children, as about half of U.S. school districts remain in hybrid instruction mode.7 This could improve in the coming weeks as schools close for summer vacation and households with children transition to fully in-person options like day care or summer camp where necessary. Generous unemployment insurance may provide an incentive for some workers to remain unemployed.8 While the $300 weekly Federal Pandemic Unemployment Compensation benefit expires September 6, many states are reacting to the possible disincentive to work by ending it earlier, removing another potential obstacle to labor supply growth.9 

Recent comments by Federal Reserve committee members suggest the central bank leadership continues to view the recent pickup in inflation as a transitory development.10 We believe these comments have helped to calm the capital markets in recent days, as they indicate the Federal Reserve is unlikely to respond to the recent inflationary data releases by tightening monetary policy. This is consistent with the long-term policy framework revision the Federal Reserve adopted in August, in which it targets an average inflationary level of 2% over time.11 Under its revised framework, the Federal Reserve may aim to respond to persistent disinflation as occurred over the last ten years by engineering an overshoot, or price gains moderately above the average 2% target for some time.

Our point of view in the great debate is aligned with the Federal Reserve: We believe the recent pickup in inflation is likely to be transitory. That said, there are of several types of disconfirming evidence whose emergence might give us pause to reconsider. If CPI and other inflation measures continue to exceed expectations, and the sources of inflation broaden to include larger and stickier components of household spend, such as shelter and health care, it would suggest that inflation may persist. In the labor market, if job openings remain at record levels, nonfarm payroll additions stagnate, and wages accelerate, we would fear a pernicious wage-price spiral taking hold. In the capital markets, the forward inflation curve implied by Treasury Inflation Protected Securities remains inverted.12 If a selloff in long-term TIPS flattened the curve, removing the inversion, that would suggest fixed income investors are anticipating a prolonged inflationary period.

If investors fear inflation will persist, we believe they will favor value stocks, and interest rate sensitive stocks, such as banks. This was apparent in the three-day selloff, as value outperformed growth, and banks outperformed the broader market.2,12 Over the last year, we have been gradually repositioning our equity portfolios to benefit from the reopening trade. This included a shift toward value and interest rate sensitive stocks. Therefore, we are already somewhat prepared for a more sustainable inflationary environment. However, we also added to cyclical exposure as part of our reopening thesis. These stocks could be vulnerable should investors worry that tighter than expected monetary and fiscal policy could slow economic growth or even spark recession. From May 10 to May 12, the Russell 1000 Value declined 3.3%, the Russell 1000 Growth declined 4.8%, the BKX bank index declined 2.9%, and the S&P 500 declined 4.0%.

In our fixed income portfolios, we have been positioned for rising interest rates for some time. This includes holding a shorter duration than our benchmark, which reduces the portfolio’s sensitivity to rising rates. We have also invested in fixed-to-floating rate securities, which may hold their value or even appreciate as interest rates rise. In addition, higher interest rates enable us to invest the funds from maturing securities into higher yielding replacements, generating more income over time than would otherwise be possible, without taking on additional risk.

1Source: U.S. Bureau of Labor Statistics. Consumer Price Index Summary. May 12, 2021.

2Source: Bloomberg and Roosevelt Investments.

3Source: U.S. Bureau of Labor Statistics. Job Openings and Labor Turnover Summary. May 11, 2021.

4Source: Bureau of Labor Statistics. Employment Situation Summary. May 7, 2021.

5Source: Wall Street Journal. Some, But Not All, of the Price Jump is Transitory. May 12, 2021.

6Source: U.S. Centers for Disease Control and Prevention. Interim Public Health Guidelines for Fully Vaccinated People. May 13, 2021.

7Source: Davidson College. Return to Learn Tracker. May 14, 2021.

8Source: Wall Street Journal. More States to Reject Extra $300 Payment for Unemployed. May 11, 2021.

9Source: Wall Street Journal. Fed’s Clarida Surprised by Inflation Report, But Stresses Need to See More Data. May 11, 2021. Fed’s Waller Says Inflation Jump Likely Temporary, Urges Patience. May 13, 2021.

10Source: Federal Reserve. Federal Open Market Committee Announces Approval of Updates to its Statement on Longer-Run Goals and Monetary Policy Strategy. August 27, 2020.

11Source: Federal Reserve Bank of St. Louis and Roosevelt Investments. On May 14, 2021, the TIPS implied five-year breakeven inflation rate was 2.68%, which was greater than the five-year, five-year forward inflation expectation rate of 2.34%.

12From May 10 to May 12, the Russell 1000 Value declined 3.3%, the Russell 1000 Growth declined 4.8%, the BKX bank index declined 2.9%, and the S&P 500 declined 4.0%.

April 2021 | Equity Commentary

Published on May 10th, 2021

April 2021 | Equity Commentary

Market Overview

The good news continued in April, with the S&P 500 index crossing 4,000 for the first time. The U.S. economy posted real GDP growth of 6.4% in Q1, nearly surpassing the pre-pandemic level of GDP. Earnings season in the U.S. is also off to a strong start, with better-than-expected results arriving as pandemic risks fade into the background. In our view, growing optimism is being reflected in sustained investor appetite for risk assets.

Earnings season is in full swing, and early signs indicate American corporations are in robust financial health. As of April 30, 87% of reporting S&P 500 companies delivered better-than-expected results, which is far higher than the historical average of 65%. Should the trend largely hold, corporate America could deliver the highest share of quarterly earnings beats since 1994.

Importantly, corporations are not just barely beating estimates—they are surprising significantly to the upside. According to data firm Refinitiv, corporations have historically beaten estimates by an average of 3.6%, but so far in Q1 2021, profits have been averaging 22.8% above expectations. All told, the recent string of strong results has S&P 500 companies on track to post their fastest rate of earnings growth since at least 2010. The caveat is that corporations have the benefit of coming off historically weak comparisons in 2020, but at the same time, earnings have rarely looked this good.

Retail sales and capital goods orders have surged beyond prior cycle peaks, which suggests more upside to S&P 500 revenue forecasts in the coming months. After the 2008 Financial Crisis, it took retail sales and capital goods orders 41 and 46 months, respectively, to pass prior peaks. In aggregate, these economic readings suggest the US economy is experiencing one of the strongest recoveries in decades.

The labor market is also showing signs of marked improvement, with the number of job openings very close to its pre-pandemic peak. Weekly unemployment claims and monthly layoff announcements have fallen to post-pandemic lows. In the Fed’s recently published Beige Book, a common theme emerged: employers were reporting shortages of workers, and many said they were having difficulty hiring. Among the areas reporting the most shortages: drivers, entry-level workers, childcare, nurses, and information technology. In other words, a fairly diverse range of jobs.

The labor force is estimated to be 5 million lower than it was before the pandemic, as many people dropped out of the labor force for a variety of reasons – boomers retiring, women staying home for childcare, people fearful of catching and spreading the virus, and/or folks who are content living on expanded unemployment benefits. But the large number of job openings—and employer frustration in filling them—may be best explained by the Economic Policy Institute’s Heidi Shierholz: “One reason is that in a system as large and complex as the U.S. labor market, there will always be pockets of bona fide labor shortages at any given time. But a more common reason is employers simply don’t want to raise wages high enough to attract workers. Employers post their too-low wages, can’t find workers to fill jobs at that pay level, and claim they’re facing a labor shortage.” April’s weaker-than-expected jobs report – with U.S. employers adding 266,000 jobs versus the expected 1 million – may be anecdotal evidence of Ms. Shierholz’s theory playing out.

Only a few weeks after the passage of the $1.9 trillion American Rescue Plan, President Biden is now pushing another $1.8 trillion package called the “American Families Plan” (this in addition to the $2.3 trillion infrastructure plan). This plan aims to expand educational opportunities and childcare, funded partly by the largest proposed tax increase on wealthy Americans in decades. The initial proposal for tax increases includes pushing the top marginal rate for individuals to 39.6%, increasing corporate taxes to 28% from 21%, and raising capital gains taxes to 43.4% for individuals who earn over $1 million annually, inclusive of the 3.8% net investment income surtax. Treasury Secretary Janet Yellen is also negotiating with foreign allies to institute a global minimum corporate tax.

It’s quite a bit to digest. Government spending feeds directly into GDP growth, but higher taxes can create distortions in the markets, particularly if the capital gains rate is doubled for a slice of the population. Efficient allocation of capital is another story altogether. At the end of the day, we know from history to watch what politicians do, not what they say. With a narrowly divided Congress, many of these proposals will likely be watered down if they make it to the finish line at all. The biggest risk to the markets in the interim, in our view, could be the legislative uncertainty to follow.

The U.S. has arguably turned a decisive corner in the battle against Covid-19. Hospitalizations in Michigan – the worst hot spot in the U.S. – are falling again, and some states are reporting zero new coronavirus deaths for the first time in a year. More than half of American adults, or close to 150 million people, have received at least one vaccine dose. In the EU, officials have finally accelerated the pace of vaccinations to the point where they are above the rate in the U.S., helping to spur a material downturn in new infections there. Brighter days look to be ahead.

As of April 30, 2021

First Quarter 2021 | Fixed Income Commentary

Published on April 16th, 2021

First Quarter 2021 | Fixed Income Commentary

Market Overview

The Current Income Portfolio (CIP) declined by -1.04% during the first quarter, with corporate bonds declining by -1.77% and preferred securities by -1.03. On a relative basis, CIP’s corporate bonds outperformed the intermediate corporate bond index return of -2.19% and CIP’s preferred securities outperformed the Wells Fargo Preferred Stock ETF (PSK) return of -1.38%.

U.S. Treasury yields increased throughout the first quarter, with the market-implied first interest rate hike by the Fed moved up to December 2022, rates climbing by over 60-80bp in each of the 5, 7 and 10-year U.S. Treasury note maturities, and the 2Y – 10Y segment of the curve growing steeper by almost 80 bps.

The sharp rise in yields drove longer duration securities to underperform to a greater degree, in both corporate bond and preferred securities markets, as their higher sensitivity to changes in interest rates effectively translated into greater losses from the move higher in rates. As a result, CIP’s corporate bonds outperformed the intermediate corporate bond market due to CIP’s slightly shorter duration. CIP’s preferred securities also slightly outperformed PSK due to CIP’s shorter duration as well as to its greater allocation to institutional fixed to floating rate preferred securities. CIP’s institutional $1,000-par preferred securities gained by about 0.94% in the first three months of the year, whereas CIP’s retail $25-par preferred securities declined by -1.55%. Institutional preferred securities, which all have fixed to floating rate coupons, held up better than retail fixed rate preferred securities due to the nature of their coupon structure, in that the floating rate component can sometimes benefit from expectations of higher interest rates. Credit spreads remained steady throughout the month, with CIP’s corporate bond credit spreads ending the quarter unchanged, relative to the prior quarter, and CIP’s preferred securities credit spreads widening slightly.

Looking forward, we expect that the impact of fiscal stimulus and vaccination progress should continue to boost economic growth and remain supportive of credit risk assets. Moreover, the Federal Reserve remains committed to highly accommodative monetary policy over the near term, with the ability to adjust the rate paid on excess reserves as well as the average maturity date of monthly asset purchases, should the need arise to make further adjustments. In addition, retail flows and demand for new issues in U.S. credit markets continue to be strong, despite the slightly negative total returns year-to-date, and yields in the U.S. also remain attractive to foreign investors on a hedge-adjusted basis.

While these factors are supportive of current valuations, CIP is positioned defensively with respect to the possibility of rising rates. Client accounts are currently funded with a shorter duration than the intermediate corporate bond market, and the duration of existing accounts edges even lower as time passes. In addition, by including fixed to floating rate coupons and limiting the fixed rate preferred securities coupon purchases to those with coupons at or above 5%, we believe CIP’s preferred securities allocation is positioned to perform opportunistically, in relative terms, than other fixed rate instruments if interest rates rise. In fact, with about one-third of the portfolio maturing in the next 1-3 years, we look forward to the opportunity to reinvest the proceeds into higher yielding securities in the future. We continue to seek to provide investors with high quality, risk adjusted, high current income without taking on excess credit or interest rate risk to do so.

As of March 31, 2021

March 2021 | Equity Commentary

Published on Apr 7, 2021

March 2021 | Equity Commentary

Market Overview

To say investors embraced “risk-on” sentiment in the first quarter may be an understatement. Most risk assets and equity categories moved higher, with value stocks and small-caps posting the biggest gains. Growth stocks moved higher, but continued to face growing headwinds from rising interest rates. We have noted in previous commentaries that extraordinary stimulus measures could result in excess liquidity sloshing around the financial markets. More liquidity supports higher prices, but it can also push investors too far out onto the risk curve (cryptocurrencies, GameStop, etc.). We believe it is important to focus on quality and to avoid “chasing” in this type of environment. For March, the S&P 500 was up about +4.4%, and this index returned +6.2% in the first quarter.

President Biden signed the $1.9 trillion ‘American Rescue Plan’ into law on March 11. The bill includes direct payments to most American households, a significant expansion to the child tax credit, an extra $300/week in unemployment benefits through September 6, and billions of dollars across state and local education, Covid-related public health measures, and additional business loans.

There is plenty more in the bill. To appreciate the scope of direct payments, consider a young, middle income family with three kids. By qualifying for the stimulus checks and the child tax credits, the family could receive perhaps $15,000 from the federal government. In short, the bill is massive, and a majority of dollars are making their way into the real economy.

The labor market continues to show signs of stabilizing. In the last week of March, just over 714,000 people filed for state unemployment benefits, which was up slightly from the week before, but still marks drastic improvement since the pandemic began. Overall hiring accelerated for the month, with U.S. employers adding a seasonally adjusted 916,000 jobs—the strongest gains since August 2020. There are more job seekers entering the labor market and more job postings available, a good sign the recovery is gaining momentum. The unemployment rate fell to 6.0%.

The tanker blocking the Suez Canal made major headlines last month, putting additional stress on already strained global supply chains. The Suez Canal is responsible for facilitating about 13% of global maritime trade and 10% of seaborne oil shipments, making any delays meaningful. The Suez bottleneck was not the only problem in March—in the ports of Los Angeles and Long Beach, dozens of container ships were continuously waiting to offload medical equipment, consumer electronics, fuel, and other goods. These two California ports handle over 30% of U.S. container imports, which helps explain delivery delays and issues with inventory restocks in the U.S.

Perhaps the most acute shortages are being seen in the supply of semiconductors, initially caused by manufacturers being caught off guard by surging demand, as the U.S. economy began its sharp recovery last spring. Demand typically declines in recessionary periods.

Supply issues were later exacerbated by even stronger demand as global economies recovered, and were dealt a further blow by a serious fire at a Japanese semiconductor manufacturer—which will likely curtail supply for at least a month. Semiconductors are used in cars, and several automakers have been forced to halt production of various makes and models due to lack of essential components. The end result is that factories are reporting the sharpest rise in prices for inputs they’ve seen in nearly 10 years, which could add to inflationary pressures this year.

The 10-year U.S. Treasury bond started the year yielding 0.9%, and as of April 1 yields 1.7%. A growing economy and expectations for higher inflation—two conditions present in the current environment—could continue pushing rates higher. We have long expected interest rate ‘normalization’ as the economy shifted back into growth mode, so rising rates do not necessarily send off any alarm bells. Rates are still very low in a historical context.

Looking ahead, inflation may be of more concern. Inflation can be pernicious if it ‘runs away’ or is left unchecked—it can suppress growth in the real economy and diminish medium- to long-term return expectations in the capital markets. In the U.S., however, the issue of the last decade has been not enough inflation, so in the short-term, higher inflation would arguably be welcomed. In a testimony to Congress this month, Chairman Powell seemed to err on the side of not worrying: “[The Fed] might see some upward pressure on prices. Our best view is that the effect on inflation will be neither particularly large nor persistent.” He also added that the Fed, for now, remains strongly committed to accommodative policy given the economic recovery still has plenty of runway.

Should inflation become an issue down the road, it is important to remember the Federal Reserve has a range of tools to combat rising prices. Raising the interest rate it pays banks on excess reserves, reducing or ending bond purchases, raising the federal funds rate—these are just a few examples of policy decisions the Fed could implement to fight inflation.

There are also deflationary forces still at work in the U.S. economy. Technological innovation has lowered the prices of many goods and services over the last few decades, and aging baby boomers are entering a period in their lives when people typically consume less, which could be a drag on demand. The pandemic appears to be accelerating retirement for many boomers, which could be another neutralizing force on price pressures.

Apart from the recent surge in Michigan and slightly higher case numbers nationally, pandemic news was largely good throughout the month. Hospitalizations and deaths continued on a downtrend, and better weather has created more spending opportunities for consumers. Air travel is also returning to levels not seen since the early days of the pandemic, underscoring the eagerness of Americans to return to normal life. Stocks have been wavering between the ‘reopening’ trade and the ‘shutdown’ trade, as investors grapple with whether companies that benefited last year during the shutdown will be able to grow as strongly now that economy is reopening.

Our largest concern about the pandemic over the past few months had been the potential for another wave of infections to sweep the country, necessitating additional shutdowns. However, with the dramatic decline in cases from the peak as well as accelerated vaccinations, we now believe it is unlikely we will see another significant wave. This, in addition to the improvement in economic data we have seen over the past month, gives us more optimism looking ahead.

What the Inflationistas May Be Missing

Published on Mar 18, 2021

What the Inflationistas May Be Missing


Investors are concerned that rising interest rates could choke off a nascent recovery. Many economists agree that long-term Treasury yields are rising because investors expect more growth and inflation. While these might be good things, you can have too much of a good thing. In particular, the pace of change matters: the roughly 75 basis point increase in the 10-year Treasury yield in the first ten weeks of this year is a rapid adjustment that creates the potential for disruption.

While we continue to monitor the situation, at this point our concerns have not reached the level where we find it necessary to safeguard our equity or fixed income portfolios from this risk beyond the natural diversification steps that we ordinarily take.

Presently, the potential for inflation is a source of angst in the investment community. But these inflationary fears come against a backdrop of decades of disappointingly low inflation, or disinflation. The drivers of disinflation have not gone away; indeed, some have intensified. Demographic pressures weigh on aggregate demand, as the proportion of U.S. residents past retirement age marches higher. Digital disruption pressures prices across the economy, with the pandemic accelerating this trend. On the other hand, globalization has stalled in recent years. While changes to trade policy may restore some global linkages, the post-pandemic priority of supply chain resilience over cost could reduce the disinflationary influence of this factor going forward.

Those who argue that we are on the cusp of outsize inflation typically focus on the nexus of fiscal stimulus, household savings, and pent-up consumer demand. However, this ignores the supply side of the economy, which will also grow with reopening. Supply growth may address shortages, relieving some pricing pressures. The nearly ten million unemployed U.S. workers is a lot of slack capacity in the labor market, which makes it difficult for pernicious inflation to sustain itself via a wage-price spiral.

Inflationistas further argue that price increases in commodities like crude oil, agricultural crops, copper, and lumber will be transmitted through the economy. But commodity prices similarly ran hot at the outset of the last economic recovery, while inflation did not follow. The U.S. economy is complex with many links in the chain that converts raw materials to finished goods. Higher corn prices on the farm are not sure to translate into higher cereal prices at the supermarket. Moreover, U.S. economic output under normal conditions is about 90% services and 10% goods. Goods inflation alone is therefore unlikely to have much of an impact on the overall economy.

There is also the unprecedented pace of asset purchases by the Federal Reserve, which has increased the money supply by about 25% from pre-pandemic levels. But the central bank purchased significant assets in the prior recovery without stoking inflation. One reason for not stirring up inflation was the payment of interest on excess reserves, a practice the Federal Reserve initiated in 2008, which creates an incentive for banks to deposit funds at the central bank, rather than lend them out. If the Federal Reserve were concerned about inflation today, it could raise the interest rate on excess reserves, which would slow the leakage of money supply growth into the real economy. This is a tool with little cost other than the political optics of paying out more to the banks. The Federal Reserve could go further if necessary, by tapering its asset purchases or raising its benchmark interest rate, but those steps would weigh on real economic activity.

Endorsing this view, Treasury Secretary Janet Yellen said last week that the Federal Reserve has learned how to manage inflation. Because of depressed comparisons in the year-ago period, inflation measures could accelerate in the coming months, generating headlines, but we expect those impacts to be transitory. Inflation expectations remain well anchored, as measured by Treasury Inflation Protected Securities, or TIPS, whose prices imply a slowdown in medium-term inflation after a near-term pickup, an inversion that is rare for this market.

Interest rates could move higher without inflation if investors anticipate a faster pace of real economic growth. If this shift were to happen slowly, with a modest accompanying rise in inflation expectations, it would be the Goldilocks scenario that the Federal Reserve wants to engineer. But if the adjustment came too rapidly, it would be self-defeating, weighing on the economy and capital markets.

Fortunately, the Federal Reserve also has tools to manage this scenario. The easiest is to shift the weighted average maturity of its asset purchases out farther along the yield curve, a maneuver that was known as Operation Twist when it was last employed in 2011. The Federal Reserve could go further if necessary, by initiating a yield curve control mechanism, as currently practiced by the Bank of Japan, by changing its forward guidance to forecast zero interest rate policy further into the future, or by increasing the overall pace of asset purchases, though these more extreme steps carry additional risks.

In analogous periods historically, rising interest rates early in economic recoveries left choppy equity markets in their wake without provoking bear market drawdowns. Bear markets typically follow the last interest rate increase by the Federal Reserve, rather than the first. In our view, there could be less equity market disruption from higher interest rates in this cycle, because the Federal Reserve is more transparent, offering substantial forward guidance, and holding press conferences after each committee meeting.

Recent easing actions by the Bank of Japan and the European Central Bank could reduce the near-term risk of dislocation because sovereign rates in these nations act as an anchor on U.S. Treasury yields. Moreover, after the rapid advance in Treasury yields over the last ten weeks, it seems reasonable there could be a pause for digestion. Lastly, in April, the Federal Reserve added a temporary exception to its supplementary leverage ratio rule for large banks, allowing the banks to own Treasury securities without holding capital against them. The exception is due to expire March 31, and large banks may be reducing their Treasury holdings in advance of this deadline, pushing yields higher. Though it has become politically fraught, we expect the Federal reserve to continue the exception for at least some Treasury holdings for some length of time, which may reduce this source of pressure on yields in the near term.

February 2021 | Equity Commentary

Published on Mar 8, 2021

February 2021 | Equity Commentary

Market Overview

Stocks rallied in the first half of February, with both the S&P 500 and the tech-heavy Nasdaq posting fresh all-time highs. Stocks were ushered higher by a strong Q4 earnings season and progressively better news regarding the availability and administration of vaccines. However, equities felt pressure later in the month from rising Treasury bond yields, which generally tends to drive volatility in high growth/high valuations stocks. The Nasdaq’s performance in February reflected the dynamic between bond yields and stocks—the index gained more on the upside during the month, but also lost more on the downside. We expect this type of volatility to persist until the market has fully adjusted to the new level of rates. In spite of the choppiness, the S&P 500 still finished February with a gain of 2.8%, while the Nasdaq finished up 1%.

By the beginning of March, nearly all companies in the S&P 500 had reported quarterly earnings, and the results were good. 77% of companies reported positive earnings and revenue surprises, with an average earnings surprise of +16%. If 77% holds, it would mark the third-highest percentage of positive earnings surprises in 12 years.

S&P 500 companies also generally raised guidance for current and future quarters, a sign that boardroom sentiment is improving. Bloomberg estimates that S&P 500 companies ended 2020 with around $2.6 trillion in cash reserves, the highest level since 2013. If the pandemic risk continues to fade and the economy pushes along the path of recovery, there’s good reason to believe some of this corporate cash buildup will be returned to shareholders in the form of dividends, buybacks, or both. We may also reasonably expect higher levels of private fixed investment, a trend which is likely to boost economic activity in the coming years.

More fiscal stimulus is on the way. The House of Representatives has already passed a version of the Biden administration’s $1.9 trillion American Rescue Plan, which includes another $1,400 in direct stimulus payments, an additional $1,000 child tax credit, and an extension of unemployment benefits to August 29. The Senate passed its own version of the bill, which the House can consider, but the price tag is not likely to change. While we still believe $1.9 trillion may be overkill relative to the current economic situation, it is difficult to make the case that additional stimulus will hurt stocks or the economic recovery in the near- to medium term. There’s the old saying that investors should not “fight the Fed.” We think that investors should not fight the federal government, either.

It is quite possible that all of the extraordinary monetary and fiscal policies, taken together, could drive inflation higher. All three Covid-19 stimulus packages featured transfer payments made by the government directly to American households and businesses, in the form of stimulus checks, expanded unemployment benefits, PPP loans, and other small business loans which effectively became grants. The M2 money supply is rising at an unprecedented 25% year-over-year rate.

Inflationary pressures are already starting to show up in the commodities markets and in US Treasury bond yields. The price per barrel of crude oil has rallied +30% year-to-date, copper prices are +50% over the past year, and the cost of shipping freight is up over +200% over the same period. Lumber prices have also doubled over the past year on the heels of a housing boom, adding materially to the cost of a new home. It seems the debate is no longer whether we are stuck in a deflationary pattern, but rather how much inflation could surprise to the upside.

While higher inflation in 2021 and beyond is certainly a rising possibility, it is not a foregone conclusion. Other conditions that tend to spur higher inflation—such as tight job markets and a lack of spare capacity in the economy—are currently missing. We believe the real risk with inflation is that it also raises the risk of monetary tightening, which could inject volatility and weigh on valuations across the capital markets. The upshot is that the Federal Reserve is more transparent than ever, with very clear and frequent forward guidance being offered to the markets. We think it is premature to expect this Federal Reserve to change course any time soon, as recent minutes indicate no appetite for monetary tightening in the near-term.

Pandemic data continues to improve. The average number of vaccine doses eclipsed 2 million per day for the first time beginning on March 3, underscoring improvement in the campaign’s organization and execution. At the beginning of February, the daily average was about 1.3 million. We expect the figures should only get better from here, as the Johnson & Johnson vaccine was cleared by the FDA, and as Pfizer and Moderna both increased production. The federal government also scored a victory by brokering a production deal between Johnson & Johnson and Merck, two companies that are otherwise rivals.

We continue to be concerned about variants of the virus, as there is little data to date about the vaccine’s efficacy against new strains. Of particular concern is the P.1 variant discovered in Brazil, which early data suggests is more contagious and may have the ability to infect even those who have already had Covid-19. All signs point to the vaccines being strong enough to mitigate the onset of an entirely new pandemic, but more data is needed to understand the scope of the risk.

January 2021 | Equity Commentary

Published on Feb 8, 2021

January 2021 | Equity Commentary

Market Overview

Stocks began the year with modest declines, as the S&P 500 fell by just over 1% during January. Investors continue to wrestle with the crosscurrents of the ongoing Covid crisis and its economic implications on the one hand, and copious amounts of fiscal and monetary stimulus on the other. While risks remain elevated, we are optimistic that the ongoing vaccination efforts can go a long way toward restoring a semblance of economic normalcy over the next several months.

Economic data has been mixed in recent weeks. Industries which tend to be more exposed to the pandemic, such as travel, leisure, and entertainment, have struggled, while more insulated areas of the economy have fared better. The December jobs report was illustrative of this dichotomy, as in the aggregate the economy shed 140,000 jobs, but strip away the 372,000 losses in restaurants and bars, and the rest of the picture appears brighter. The majority of industries added jobs during the month, and the unemployment rate held steady at 6.7%. Retail sales have weakened of late, as December marked the 3rd consecutive month of sequential declines. It is likely no coincidence that this weakness has transpired during a period in which Covid cases were rising precipitously. While the pandemic has impacted many businesses negatively, the housing market has been a notable exception, as it has benefitted from both deurbanization and nesting trends, as well as the historically low mortgage rates available in the aftermath of the Federal Reserve’s interest rate reductions and asset purchases. Single-family starts and permits were quite strong in December, just the latest in a long line of healthy housing market indicators over the past several months.

The Federal Reserve held its latest FOMC meeting last month, and our takeaway is that the committee remains quite dovish. The Federal Reserve downplayed near-term inflationary concerns and reiterated that it remains premature to begin tapering asset purchases. Its base case for the economy is that strong growth is likely to resume as vaccines become more widely available, though it noted the downside risks associated with a slow initial vaccination rollout and new Covid variants. In our view, the Federal Reserves’ risk assessment is more heavily weighted towards the near term, while its longer-term outlook is more bullish. We therefore think it is all the more important that Congress was able to pass the most recent $900 billion fiscal stimulus bill at the end of December, and we believe that more aid will be forthcoming with Democrats now in charge of the executive and legislative branches. Historically, the central bank has been prone to tighten policy in response to financial market instability, and in this regard, there was some concern that froth in certain pockets of the market might force the hand of the Federal Reserve. Federal Reserve Chairman Powell, however, allayed these concerns by making it clear that he is far more concerned with achieving his goal of maximum employment, the implication being that monetary policy is likely to remain highly accommodative for the foreseeable future.

President Biden recently proposed a $1.9 trillion fiscal stimulus plan, which is largely comprised of increased unemployment benefits, additional stimulus checks, support for state and local governments, and funding for coronavirus vaccinations and testing. Republicans have most recently countered with a $600 billion proposal of their own. While Democrats could use the budget reconciliation process to enact much of $1.9 trillion in support that they are seeking, President Biden has suggested that his preference would be to work with the GOP to reach a mutual agreement. Ultimately it appears highly likely that some degree of incremental stimulus will be passed. With today’s economy being significantly stronger than it was last year when the CARES act was enacted, we do not think that the full $1.9 trillion is necessary. In our view, any amount in between the range of the two proposals would be sufficient to support the economy and satisfy capital markets. We are cautious, however, that inflation could create challenges over the long term. Over time, as the economy fully reopens, the release of pent-up demand alongside of the lagged effects of historic amounts of fiscal and monetary stimulus could unleash a powerful growth phase. This could drive inflation higher and take bond market yields with it, creating a less favorable environment for stocks, in our view.

Covid remains a key risk factor for the economy and capital markets. The path of the pandemic will likely dictate the future course of the economy, and in this regard, we are concerned with the latest variants of the virus which may be more highly transmissible, and perhaps less vulnerable to the current generation of vaccines. It is therefore not out of the realm of possibility that we see yet another wave of infections, perhaps during the spring. That being said, it does appear that vaccines remain effective in reducing worst-case outcomes from the new coronavirus strains. That could make a potential next wave less problematic for the economy, as we assume that policy makers would be less likely to impose additional lockdowns if there was a lower probability that the health care system would be overburdened without them. While risks remain elevated, we are optimistic that between the vaccinations currently being administered, and those in various phases of development, that the resources are available to foster a return to normalcy over the near to intermediate term.

December 2020 | Equity Commentary

Published on Jan. 8, 2021

December 2020 | Equity Commentary

Market Overview

Stocks finished the year on a strong note, as the S&P 500 gained 3.7% for December and about 11.7% for the 4th quarter overall. We believe investor enthusiasm was largely driven by the FDA approval and initial roll-out of two highly efficacious COVID-19 vaccines, which have enabled markets to begin to price in a return to normalcy over the next several months. While coronavirus cases continue to surge and economic conditions may deteriorate in the near term, we remain optimistic that the new vaccines, alongside of copious amounts of fiscal and monetary stimulus, can act as meaningful support factors for the stock market.

Economic data appears to have cooled in recent weeks, though relative to economist expectations we think the economy has held up fairly well in the face of sharply rising coronavirus cases. Housing continues to be a bright spot, as the National Association of Home Builders housing market index remains close to all-time highs, and single-family starts and permits are at their best levels in over a decade. Other areas of the economy, however, have faced greater challenges. Weekly unemployment claims, which had been in a declining trend since the summer, ticked up again in December, suggesting that the increase in COVID cases and related shutdowns are once again negatively impacting employment. The monthly payroll data for November was aligned with this view, coming in well short of expectations and meaningfully below October’s reading. Retail sales also weakened in November, falling by 1.1% on a month-over-month basis, missing the consensus call for a 0.3% decline.

Coming off a robust rebound in the 3rd quarter, we expected that the economy would decelerate during the 4th. We think that the key issue for investors was not whether growth might slow, but rather to what extent. Given the sharp spike in COVID cases and the government’s inability to agree on a new fiscal stimulus bill until the end of December, we were quite pleased with the resiliency of the economy and are optimistic that it may continue to surprise to the upside into the new year. We view the $900 billion pandemic relief bill which was signed into law late last year as a key support factor for the economy, and think that it will help to sustain business activity over the next few months until vaccines are expected to be widely available. The bill should help to support consumers and small businesses through stimulus checks, enhanced unemployment benefits, and emergency lending programs. In our view, the prior stimulus bill had a significant impact during a period in which the economy was in a weaker state than it is currently, and we are therefore optimistic that this latest stimulus package can help to turbocharge an economy which has already been showing signs of resiliency. As well, the Democrat sweep of the Georgia senate election runoffs may result in additional fiscal relief, which, if it comes to pass, should provide even more support for the economy.

The Federal Reserve held its latest FOMC meeting last month, and our key takeaway is that while it slightly raised its economic forecast, interest rate guidance remained the same. This is significant, as it is an early indication that the Federal Reserve is staying true to the new policy framework announced last summer whereby it may allow the economy to run hotter than it previously would have before beginning to raise interest rates. We view this shift in strategy as dovish, and therefore were encouraged that this latest upgrade to its economic projections were not accompanied by a change in interest rate guidance. We think that this lends credibility to the idea that the Federal Reserve is in fact committed to adopting its new, more flexible, policy framework.

As we look ahead, COVID remains a key risk factor for markets. We are concerned that a new strain of the virus, which may be more contagious, could lead to more lockdowns and further inhibit economic activity. It is therefore that much more important that vaccines are rolled out expeditiously, though thus far this has not been the case. The initial rollout has been slower than expected, perhaps not too surprising given the challenges inherent in public-private partnerships along with the logistical complexities of this endeavor. We are optimistic, however, that the pace of the vaccination initiative will improve over time. Looking out over the medium term, there is some risk that a full reopening of the economy, pent-up demand, and the lagged effects of fiscal and monetary stimulus could lead to an economic boom causing inflationary pressures and sharp increases in yields, ultimately weighing on stocks.

Despite these significant risk factors, we see reasons for optimism. We think that the latest fiscal stimulus package can go a long way towards helping to sustain economic activity until vaccines are more widely available. As well, the FDA may approve additional vaccines for emergency use in the coming months, which would help to shorten this interim period of heightened economic vulnerability. The Federal Reserve continues to inject liquidity into the financial system through its $120 billion of monthly asset purchases, and has pledged to continue doing so until it sees substantial further progress towards its goals of maximum employment and price stability. The use of the word ‘further’ in its statement is noteworthy, as it clarifies that the Federal Reserve is looking for substantial progress from current conditions, as opposed to those during depths of the recession. In our view, it is therefore safe to assume that the Federal Reserve will continue to keep monetary policy highly accommodative for the foreseeable future. We expect that this combination of fiscal and monetary stimulus may continue to act as powerful tailwinds for stocks, particularly against the backdrop of an economy that has shown impressive resiliency, and optimism that we may finally be approaching the end of this pandemic-plagued period.

As of December 31, 2020

November 2020 | Equity Commentary

Published on Dec. 8, 2020

November 2020 | Equity Commentary

Market Overview

Markets enjoyed an historic November, with multiple indices hitting all-time records, including the S&P 500 which was about 11% higher for the month. Investors were likely encouraged by better than expected results from Covid-19 vaccine trials, and it now appears likely that a vaccine may be available on a widespread basis by the middle of next year. We also think that investors were pleased with the U.S. election, which looks to have resulted in a divided government, though some uncertainty remains as the balance of power in the Senate will not be resolved until the Georgia runoffs in early January.

Stocks showed strength during November. The Russell 2000 advanced just over 16%, its best monthly performance since the index began in 1984, and the S&P 500’s 11% gain marked its strongest November since 1928.We believe the key catalyst for these gains was progress on the coronavirus vaccine, as there finally appears to be some light at the end of this dark, pandemic plagued period. For the first time in a while, economists may be able to project a return to normalcy, perhaps over the next several months as vaccines are rolled out on a widespread basis.

To be sure, current conditions remain challenging. In the U.S., new cases and hospitalizations are shattering prior peaks from earlier in the year, and it seems likely that conditions will continue to deteriorate over the near term. Still, there are reasons to believe that capital markets can endure this interim period, particularly if economic activity continues to hold up well. Prior peaks ultimately receded after people adapted their behavior to reduce infection risk. These behaviors also provided health care professionals, policy makers, and corporations valuable experience in managing their way through the pandemic. We are therefore optimistic that despite the difficult conditions that are likely to persist over the next few months, stocks need not suffer the same fate as earlier in the year when markets crashed during the beginnings of the pandemic.

We have been impressed with the resiliency of economic activity over the last several weeks. Our expectation was that growth was likely to decelerate with coronavirus conditions worsening and the stimulative effects from the CARES Act waning. However, it appears that the economy has held up rather well. Markit’s November composite PMI, which aggregates the service and manufacturing sectors, came in at a healthy 57.9, the best mark in over 5 years. Housing remains robust, with continued strength in existing home sales and a record high NAHB homebuilder survey aided by very low mortgage rates. This may also bode well for future expenditures on renovation and repair activity. While November’s monthly jobs report missed expectations, we believe that this may increase the odds of an agreement on a fiscal stimulus package before year end.

Heading into last month’s election, our view was that a key risk factor was the possibility of a sustained period of uncertainty given the potential for a contested result, perhaps similar to what transpired during the 2000 presidential contest. In this regard, while President Trump has yet to concede and there are still lawsuits working their way through the courts, all indications are that come January Joe Biden will be inaugurated as the 46th president of the United States of America. There remains uncertainty in the Senate however, where the balance of power will not be determined until the Georgia runoffs next month. Still, with Democrats having to take both races to secure the majority, we think the most likely outcome, and the one which is currently baked into markets, is a divided government with a Democratic president and House majority, and Republicans maintaining control of the Senate. We think that this scenario would have mixed implications for capital markets. It is unlikely that much would change with regards to U.S. tax policy, which we view as market friendly. However, we think that the likelihood of another large round of fiscal stimulus next year may be lower should Republicans hold the Senate majority.

We do expect that at some point, should these risks moderate and the expansion prove sustainable, that these aforementioned sectors of the market will begin to out perform. A successful passage of an additional stimulus bill would also likely benefit these types of stocks disproportionately, in our view. However, we believe that the most prudent strategy to navigate these turbulent currents is to take a diversified, balanced approach. We continue to own shares of companies that we expect should perform well as economic growth recovers, but we also maintain positions in companies that we think would be relative out performers should rising COVID-19 cases necessitate further shutdowns, resulting in weaker economic activity.

The key debate for investors going forward, in our view, is whether and to what extent an air pocket may develop in the coming months, whereby worsening coronavirus conditions derail the economy prior to vaccines becoming widely available. The early indications from a capital markets perspective in this regard have been quite positive, as stocks soared last month on favorable vaccine news despite the sharp increase in new COVID case counts and hospitalizations. Investors have at least thus far been looking through the deteriorating near-term circumstances and have focused instead on the potential for a return to normalcy.

We see reasons for optimism that investor sentiment may remain constructive in the coming months, as we are confident that monetary policy will stay highly accommodative, and we continue to expect at least some degree of additional fiscal stimulus. Moreover, the economy has thus far been quite resilient despite the challenging environment, and multiple forecasts that we track are calling for a strong 4th quarter. Still, risks remain elevated, and it is certainly possible that economic activity may yet fall victim to this latest, most severe wave of the pandemic. In our assessment, however, progress on vaccines and the likelihood of forth coming stimulus should continue to counteract these risks and serve as powerful support factors for stocks, as investors anticipate a hoped-for return to normalcy next year.

As of November 30, 2020

October 2020 | Equity Commentary

Published on Oct. 31, 2020

October 2020 | Equity Commentary

Market Overview

Stocks finished lower during October, as the S&P 500 declined about 3% for the month. While the economy continues to heal, markets have been buffeted by the sharp increase in coronavirus cases in the U.S. and Europe, and the lack of progress on a new stimulus bill. Moreover, the period leading up to an election can be volatile even in less uncertain times. Nevertheless, we see reasons for optimism. A stimulus bill may be easier to pass following the election, the Federal Reserve may step up its accommodation, and numerous phase III trials are currently underway in the race to discover an effective vaccine for COVID-19.

Economic data continued to firm in recent weeks. Third quarter GDP rebounded at a 33.1% annualized pace, coming off an historically weak, pandemic-plagued second quarter. The housing market remains quite strong. While both new and pending home sales cooled slightly in September, the NAHB homebuilder survey notched another record high and the latest reading of single-family starts and permits hit levels not seen since 2007. Durable goods orders for September beat consensus expectations and now sit above pre-pandemic levels. The labor market has also shown signs of improvement, with initial unemployment claims recently falling to the lowest level in several months, though they do remain quite high by historical standards.

One aspect of the third quarter recovery that we were particularly encouraged by was the strength in newly formed businesses. New businesses formation in the U.S. increased by 77% to a record level during the quarter. We attribute this to a confluence of factors, including the skyrocketing unemployment in the wake of the pandemic, the on average $1,200 payments received by many households as part of the CARES act, and the abundance of online tools currently available to assist the would-be entrepreneur in starting a business. We see this as confirmation of the resiliency of the U.S. economy, and expect that it should help to support economic activity moving forward.

Third quarter earnings season looks to be off to a strong start. With approximately 60% of the S&P 500 having reported as of this writing, 81% of companies have exceeded earnings expectations. While aggregate earnings per share are down 12.5% on a year-over-year basis, this compares quite favorably with analysts’ forecasts for declines of greater than 20%. Most importantly, as investors base stock values on future cash flows, earnings expectations for the coming year have been trending higher.

Elections can be key sources of uncertainty for capital markets. We have noted that historically stocks tend to weaken prior to, and strengthen following, elections as investors gain more clarity and insight into the political landscape. The biggest risk factor pertaining to the election might be the potential for a significantly delayed result. In our view, markets are likely to shrug off a few additional days of uncertainty, but a longer delay could derail stocks as was the case following the 2000 Presidential contest during which the S&P 500 declined by about 8.4% from November 7th through December 15th when Al Gore ultimately conceded. We do note, however, that the implied future volatility in both equity and foreign exchange derivatives has come down over the last month, suggesting that investors are becoming less concerned about the immediate aftermath of the election.

Another risk facing investors is the lack of progress on a new stimulus bill, particularly in light of the worsening coronavirus conditions across much of the country. The decline in the personal savings rate in recent months suggests that more stimulus will likely be needed to sustain consumption, a key cog of the U.S. economy. We remain optimistic, however, that the prospects for getting a deal done should brighten once the election results are in, and the negotiating parties know better where they stand. Should the pandemic conditions deteriorate further, it would likely put more pressure on politicians to reach an agreement.

Uncertainty may be reaching a crescendo, as investors wrestle with a new wave of infections across the country and the polarizing political landscape. However, we see multiple countervailing factors which keep us from taking too bearish an outlook. There are currently multiple phase III trials underway as pharmaceutical companies continue to work towards developing a vaccine for COVID-19. We would expect that approval of a highly efficacious vaccine would go a long way towards boosting investor spirits as it would considerably lessen a major risk to economic activity and provide light at the end of a long tunnel. We also think that the initial wave of the pandemic which hit the U.S. in the spring has given policy makers and corporations some experience in managing through lockdown conditions, perhaps enabling future restrictions to be more targeted and less detrimental to corporate profitability. Similarly, hospitals appear to be having more success treating patients.

Another key support valve for markets, in our view, is the Federal Reserve, which we believe has more dry powder at its disposal to help to boost the economy. We think that more can be done to backstop credit markets through the Federal Reserve’s various lending facilities, and asset purchases can be ramped up should conditions warrant such actions. Moreover, as noted above, we do expect that ultimately another fiscal stimulus bill will get passed. As we manage through these various crosscurrents, we continue to believe that a balanced portfolio is the best approach. We therefore continue to bifurcate our portfolios with allocations to companies that could do well in lockdown scenarios, as well as to those that we would expect to outperform under better growth conditions.

As of October 31, 2020

September 2020 | Equity Commentary

Published on Oct. 9, 2020

September 2020 | Equity Commentary

Market Overview

Overall, markets enjoyed a strong third quarter, with the S&P 500 returning close to 9% for the period. While July and August saw robust gains, the index closed out the quarter on a weaker note, falling nearly 4% during September. In our view, this reflects an economy which is transitioning from a strong rebound phase following the pandemic-plagued second quarter, to a slower, more normalized pace. With the election just around the corner, the political environment remains highly uncertain and volatility is elevated. We continue to believe that a balanced, well diversified portfolio is the best way to navigate today’s capital markets.

Recent economic data releases have generally been favorable, in our view. The housing market continues to be robust. The NAHB home builder survey and pending home sales recently hit all-time highs, and existing and new home sales are at their best levels since 2006. We do think that low housing inventories may be a constraining factor going forward, but for the moment the market remains quite strong. Consumer confidence is also strengthening, as both the University of Michigan and The Conference Board indicators for September came in at the best levels since the pandemic hit the U.S. We are also seeing continued improvement in the automotive industry, as vehicle sales have exceeded expectations every month since April.

Other releases have been more mixed. September manufacturing surveys indicate that growth may be moderating as both the ISM and Markit surveys came in below consensus expectations. However, they remained in the mid-50s range, a healthy level, in our view. ISM’s service sector reading for September looked relatively stronger, as it surprised to the upside and came in near its post-pandemic high. The September jobs released is appointed, as job creation slowed to about 661,000 for the month. However ,much of the decline was in government employment, while the private sector fared better.

We believe these indicators collectively suggest that the economy may now be in a transition phase, perhaps regressing back towards the low single digit GDP growth that has been typical in recent years. We expect that GDP growth for the third quarter will be exceptional, but certainly not sustainable, as it will reflect there bound from the historically weak second quarter. Therefore, the recent deceleration in job growth and manufacturing should not be viewed as anything beyond what one would normally expect from an economy which is transitioning from a sharp rebound phase to a more normalized, lower growth environment.

The Federal Reserve held its latest FOMC meeting last month, and our takeaway is that the committee was dovish on interest rates, but perhaps less so with regards to asset purchases. On rates, the Federal Reserve noted its intention to maintain its current stance until maximum employment was reached, and inflation was on track to exceed 2% for a sustained period. Given that the committee doesn’t expect these conditions to be met until the latter part of 2023, the implication is that interest rates are likely to remain near zero for the next couple of years. There was some disappointment, however, that the Federal Reserve did not provide additional guidance

around its pace and scope of asset purchases. We think that it’s possible that committee members refrained from doing so to maintain pressure on Congress to pass another stimulus bill. Inaction may also reflect a view that further monetary stimulus is less impactful while new U.S. cases are elevated, which might push the Federal Reserve to conserve its firepower. Still, we do expect that should the economy weaken, that the Federal Reserve would ultimately ramp up its asset purchases, so as to advance its mandate of promoting maximum employment.

Typically, at this point early in an economic recovery, we would expect small cap, value, and cyclical stocks to be leading the market, but for the most part this has not been the case. We think that the reason is the high degree of uncertainty in the current environment, given the turbulent political landscape as we approach the election, and the persistence of COVID-19. On the former, the uncertainty has only increased with the recent passing of Justice Ruth Bader Ginsburg and the on going attempt to confirm her successor on the Supreme Court, and President Trump’s hospitalization for the coronavirus. Moreover, with COVID-19 case counts again on the rise across much of the country, it remains possible that economic activity will continue to be impacted. In this regard we note that several states are currently in the process of reversing prior re-openings due to worsening coronavirus conditions. On the other hand, we are optimistic that an effective vaccine would give a material boost to economic activity and market sentiment.

We do expect that at some point, should these risks moderate and the expansion prove sustainable, that these aforementioned sectors of the market will begin to out perform. A successful passage of an additional stimulus bill would also likely benefit these types of stocks disproportionately, in our view. However, we believe that the most prudent strategy to navigate these turbulent currents is to take a diversified, balanced approach. We continue to own shares of companies that we expect should perform well as economic growth recovers, but we also maintain positions in companies that we think would be relative out performers should rising COVID-19 cases necessitate further shutdowns, resulting in weaker economic activity.

As of September 30, 2020

Weighing the Impact of a Historic U.S. Presidential Election

Published on Oct. 1, 2020

Weighing the Impact of a Historic U.S. Presidential Election

The 2020 U.S. presidential election is fast approaching. No matter what your political orientation, this election cycle probably feels highly consequential and filled with uncertainties. And as if the election wasn’t enough, there is still a pandemic looming in the backdrop with an economy fighting to regain footing.

As the old saying goes, never a dull moment.

Read the Full Article Here

Thoughts Ahead of the Federal Reserve Meeting

Published on Sep. 9, 2020

Thoughts Ahead of the Federal Reserve Meeting

We believe there may be more uncertainty around the Federal Reserve’s upcoming mid-September Open Market Committee meeting than is typical. It will be the first committee meeting since last month’s virtual Jackson Hole meeting, at which the Federal Reserve announced revisions to its statement on longer-run goals and monetary policy strategy, and it is the last scheduled meeting before the U.S. election in November. We see four main possibilities as to what actions the Federal Reserve may take at this meeting: (a) provide forward guidance on the Federal Reserve Funds rate; (b) provide forward guidance on its asset purchase program; (c) provide both; or, (d) do nothing. We believe any forward guidance provided would be outcomes-based, meaning it would commit the Federal Reserve to an action until an economic target is achieved, rather than until a specified time has elapsed. The purpose of any Federal Reserve action would likely be to pivot from crisis management to a policy that may support and sustain the nascent economic recovery.

Read the Full Article Here

August 2020 | Equity Commentary

Published on Sep. 9, 2020

August 2020 | Equity Commentary

Market Overview

Stocks continued their ascent during August, as the S&P 500 surged about 7% for the month. We believe that a resilient economy, better than expected corporate earnings, and improving trends in new COVID-19 cases were likely all factors helping to propel the market to new highs. The Federal Reserve most likely buoyed investor spirits by introducing a new dovish policy framework, effectively confirming the prevailing view that interest rates are likely to remain at historically low levels for some time to come.

We were encouraged by the economic data released during August. Most national surveys of the manufacturing and service sectors continued to trend favorably, and the July jobs number came in ahead of expectations with nonfarm payrolls increasing by 1.76 million. The housing market continued to impress us with the latest tally of starts and permits increasing by 22.6% and 18.8% respectively on a month-over-month basis. July new home sales came in at the best level since 2006, and the NAHB homebuilder survey matched a record high. It seems evident to us that extremely low mortgage rates are helping to propel a robust housing market.

We believe while resilient and even quite strong in certain areas, the economy is by no means firing on all cylinders, though that is to be expected amid the COVID-19 pandemic. The most recent Empire and Philly Fed regional manufacturing surveys missed consensus expectations, and the Conference Board’s consumer confidence reading for August declined to its lowest level since 2014. New claims for unemployment have stalled at around 1 million per week, and while this is below recent peaks it remains materially above the pre-pandemic high of about 695,000 reached back in October of ’82. While this raises some questions about the health of the labor market, we do note that total unemployment claims have been trending favorably, perhaps indicating that new hiring has been able to mitigate the stubbornly high level of new claims.

A potential hurdle facing the economy and capital markets is the lack of progress on another stimulus bill. While the Trump administration did attempt to step into this breach with a series of executive actions, it appears likely that legal and operational challenges could minimize their effectiveness. We have seen estimates that these measures will provide less than $100 billion of economic support, compared with expectations for over $1 trillion from an additional fiscal stimulus bill. As a result, there are concerns among investors that the economy may be at risk for another slowdown. However, we have yet to see evidence of this in the economic data.

Federal Reserve Chairman Jerome Powell delivered a notable speech at the annual Jackson Hole Economic Symposium, detailing key takeaways from the central bank’s recently completed framework review. We think the principal message was that the Fed will allow unemployment to fall below its estimate of the natural rate (of unemployment) without necessarily raising interest rates, which previously would have been its typical policy response. It is also moving towards an average inflation objective, a change from its past practice of targeting a specific rate of 2%. It will accept somewhat higher than targeted levels of inflation given that they occur following periods that fell below trend. We believe the earlier Fed will generally attempt to be more flexible with its policy responses in these regards. This new framework was adopted than expected in a unanimous vote by the Federal Open Market Committee. We view these changes as dovish insofar as they can be taken as confirmation that rates are unlikely to be moving higher at any time soon.


Growth stocks continued to outperform value in August, as was the case in June and July. While we believe that this trend is likely to shift and favor value stocks as the economy recovers, to date this has not occurred since the market’s rebound from the March low. This may be in part due to the lack of a fiscal stimulus bill, which had it been passed, we believe would have disproportionately benefitted more cyclically oriented companies. Still, we are comfortable with our current portfolio positioning which we believe is well balanced on both a style and capitalization basis. It is our view that small cap companies and value companies are likely to outperform in a positive scenario whereby the coronavirus continues to trend downward, and economic growth continues to recover. Conversely, we would expect larger cap stocks and growth stocks to be relative outperformers should another wave of the virus lead to more lockdowns and weaker economic conditions. We continue to view either scenario as well within the realm of possibility, and therefore believe that our current positioning is the most prudent means of navigating today’s capital markets.

As of August 31, 2020

“Not Even Thinking About Raising Rates”

Published on Aug. 27, 2020

“Not Even Thinking About Raising Rates”

Thus said Fed Chair Jay Powell this past June. But what exactly does this mean and why did he say it?

It’s all about inflation. That is, the inflation we don’t have. Missing in action. The Fed actually desires some inflation, at least a little, generally defined as 2%. Those old enough to recall serious thinking about inflation during Paul Volcker’s tenure in Powell’s seat at the Fed remember inflation being described as a catastrophe. Nothing crushes bond holder returns like unexpected inflation. Nothing damages consumer spending like inflation when personal income is constrained. Facing this, Volcker used the interest rate tool to crush it. Further, he broadcast the message that the Fed always stood ready to do so again. Given that, realistically, inflation hasn’t made much of an appearance since that period from the late 1970s to the early 1980s.

Why would the Fed want to rekindle it?

Read the Full Article Here

July 2020 | Equity Commentary

Published on Aug. 11, 2020

July 2020 | Equity Commentary

Market Overview

Stocks began the 3rd quarter on a strong note, with the S&P 500 returning about 5.6% for July. We believe that economic data continued to stabilize during the month, and 2nd quarter corporate earnings have thus far come in well ahead of investor expectations. Covid-19 remains a key risk factor for stocks and the economy moving forward. While uncertainty remains elevated, we expect that Congress will soon pass another round of fiscal stimulus, and we believe that the Federal Reserve will maintain its accommodative monetary policies for the foreseeable future.

Most key economic data releases have exceeded consensus expectations over the last several weeks. July ISM surveys (both manufacturing and non-manufacturing) made month-over-month gains, continuing the trend of June’s improvement, and moving back to levels we believe to be consistent with economic expansion. This strength looks to have been confirmed by the Federal Reserve’s regional manufacturing surveys for July which came in at robust levels. Moreover, recent readings on industrial production, durable goods orders, and retail sales have all come in ahead of economists’ projections.

In our opinion the housing market also appears quite healthy. While housing typically lags during recessions, the increased time spent at home due to Covid-19 has motivated many consumers to make meaningful investments in their homes. We have also seen that Covid-19 has led to an increase in demand for houses in the suburbs and more rural areas. These factors, along with the significant decline in mortgage rates, appear to be a boon for the industry. This is not only showing up in the economic data, with metrics such as the NAHB homebuilder survey and existing home sales showing strength, but we are also hearing positive indications from housing suppliers. Paint producers, pool companies, and HVAC systems providers are a few examples of housing-related businesses which have noted the robust condition of their end markets on recent industry conference calls.

Not all the economic data has been positive. A headline grabber was the recently released 2nd quarter GDP, which came in at an historically weak approximate 32.9% annualized decline. However, we were not overly concerned by this reading given that it was widely expected and is also a backward-looking indicator. Clearly the 2nd quarter was an ugly one due to Covid-19-related shutdowns, but it also seems evident that the economy has strengthened considerably since then. Perhaps of greater concern are the weekly unemployment claims numbers, which have remained stubbornly high, and have in fact increased in recent weeks after having been steadily declining since late March. We believe the volatility in weekly unemployment data is likely the result of the jump in new Covid-19 cases which began during the latter part of June and continued to increase through July. It seems evident to us, that Covid-19 continues to impact economic activity. Fortunately, the growth in new cases and hospitalizations appear to have declined during the latter part of July, and we are optimistic that the economy can resume its rebound should this favorable trend prove to be sustainable.

With a large majority of S&P 500 companies having reported their 2nd quarter profits, aggregate earnings are coming in well ahead of what were admittedly very weak expectations. Companies appear to be exceeding top line estimates by a couple of percentage points, but the highlight to us, is on the bottom line where average corporate earnings are beating expectations by over 25 percentage points. Many companies have also noted the positive linearity of the quarter, whereby there was sequential improvement in business conditions each month. Still, many companies have not given forward guidance, highlighting the fact that the environment remains quite challenging to predict due to the lingering pandemic.

As we look forward, we note that conditions remain highly uncertain. Clearly Covid-19 is playing a large role in this uncertainty, but other factors are at play as well. As of this writing, Congress has yet to agree on another Covid-19 relief package. We think that it is crucial that another bill is passed to support the consumer as well as state and local governments, and that economic activity is likely to suffer otherwise. While it is unfortunate that the issue remains unresolved, we do expect that there will be a favorable resolution in the near term.

The election represents another source of uncertainty and volatility for investors. The outlook for tax, regulatory, and other policies will vary materially depending on the outcome. Markets tend to weaken prior to and strengthen in the aftermath of elections. In our view this is likely a function of the greater clarity that investors gain once the election is over and leadership is established.

As a result of these uncertainties, we continue to think that a diversified portfolio is the best approach to navigating capital markets. In our view, the two most likely scenarios for markets going forward include one in which economic activity continues to improve, and another characterized by weakness resulting from the continued spread of Covid-19. Under the first scenario, we would expect that cyclical stocks would be among the winners, while we believe that tech stocks with secular tailwinds, and more traditional defensive holdings would outperform under the 2nd, weaker growth scenario. Given the difficulty of predicting the future course of Covid-19, we maintain our barbell approach whereby we are investing for both outcomes, focusing our efforts on ensuring that our portfolios can do well under either scenario, as opposed to making a large macro bet one way or the other.

As of July 31, 2020

Second Quarter 2020 | Fixed Income Commentary

Published on Jul. 20, 2020

Second Quarter 2020 | Fixed Income Commentary

Market Overview

Domestic financial markets rallied across the spectrum during the second quarter of 2020. Equity indices had their strongest quarter since 1987. Fixed income credit spreads rallied, recording their second-best quarter since 2005. We believe that the re-opening of state and local economies led to a resurgence in economic activity that beat expectations over May and June. The unemployment rate, after reaching an eighty-year high of about 14.7%, dropped to an estimated 11.1%. Other economic indicators such as consumer confidence, consumer and business spending, housing starts, as well as surveys of manufacturing activity, surprised to the upside over the past two months.

The Current Income Portfolio separately managed account returned 7.30% during the second quarter, as declines in interest rates and credit spreads helped push up the prices of corporate bonds and preferred securities, while having less of an effect on government bonds. We believe that the decline in bond yields came from a reversal in risk sentiment as financial markets digested the monetary and fiscal stimulus programs set up in response to the pandemic.

In March, the Federal Reserve re-emerged as the lender of last resort, introducing $2.3T in monetary stimulus programs to restore liquidity and financial stability to the markets. In doing so, the Federal Reserve expanded its asset purchasing program to include ETFS and corporate bonds, in addition to the approximate $120B of government and agency securities it currently buys each month. The program, known as the Secondary Market Corporate Credit Facility (SMCCF), began buying high quality corporate bond ETF’s on May 16th, at a pace of about $300M per day, and individual high quality corporate bonds on June 17th, albeit at a slightly slower pace. The entire amount of secondary market ETF and corporate bond purchases currently stands at approximately $6.8B as of June30, with the ability to go up to about $750B if needed. This extends an incredible amount of support to the investment grade fixed income market, as corporate bond purchasing has just begun and the Federal Reserve is already the second largest holder of Vanguard’s Short-Term Corporate Bond ETF (VCSH), and third largest holder of the iShares Investment Grade Bond ETF (LQD).

The Federal Reserve, however, has not been alone in buying U.S. corporate bonds this year. Even as companies have issued record amounts of new debt to shore up liquidity on their balance sheets, the issuance has been met with equally strong investor demand. Fixed income buyers have absorbed over $1T in new supply year to date; which, in turn, has helped send credit spreads on intermediate investment grade bonds lower by over 150bps during the second quarter.

With signs of a V-shaped recovery emerging from economic data and subsequently called into question as the number of new COVID-19 infections is rising, we believe the outlook for the economy as a whole for the rest of the year remains uncertain. The outlook for investment grade fixed income markets, however, is much more favorable, in our opinion. The current support from the Federal Reserve should serve as a significant backstop and important distinction between high grade and high yield fixed income markets going forward. High yield markets also happen to be concentrated in segments of the market that we see as more susceptible to an economic downturn, such as the consumer cyclical and energy sectors. Investment grade companies, on the other hand, are generally larger, more diversified, less levered and more concentrated in defensive sectors. This, coupled with the recent message delivered by Federal Reserve Chairman Powell saying, “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” could provide for a benign and favorable interest rate environment for high grade fixed income for the foreseeable future.

In our view, the Current Income Portfolio is well positioned to deliver consistent and reliable income regardless of the economic uncertainty that prevails. We believe our risk-conscious approach to portfolio construction ensures a balance between enhancing income without taking on excessive risk to do so. We continue to navigate the financial markets’ ups and downs while attempting to provide investors with high quality risk-adjusted returns.

Second Quarter 2020 | Equity Commentary

Published on Jul. 8, 2020

Second Quarter 2020 | Equity Commentary

Market Overview

Stocks enjoyed a strong 2nd quarter, with the S&P 500 returning just over 20% for the period. We believe fiscal and monetary stimulus, along with improving economic data, helped to drive this rebound following a difficult start to the year. While we are encouraged by the litany of data points which suggest that economic activity has strengthened over the past few months, the rising number of COVID-19 cases across much of the country is disconcerting, and in our view remains a key risk factor for capital markets moving forward.

The majority of economic data released over the last several weeks suggest that after contracting earlier in the year, the economy has entered a recovery phase. Following a decline in April, retail sales rebounded in May with an approximate 17.7% advance. Household spending also grew by about 8.2%. Surveys of both the manufacturing and service sectors also improved in May relative to April, though at a more modest pace. Economic activity appears to have continued to strengthen into June, as regional Federal Reserve manufacturing surveys for the month showed robust gains, with the Empire, Philly, and Dallas surveys being particular standouts, to us. June’s progress was not limited to the manufacturing space, as consumer sentiment ticked up for the month as well. The Citi Surprise Index, which quantifies how actual economic data is faring relative to consensus expectations, has surged of late, marking an all-time high after having plunged to record lows just a couple of months ago.

In our view, these improvements are a function of fiscal and monetary stimulus initiatives, along with the release of pent-up consumer demand. Earlier in the year, social distancing mandates and lock downs, implemented in order to counter the spread of COVID-19, effectively shut down a significant portion of the economy. As states began to allow businesses to reopen, pent-up consumer demand, alongside direct payments to households and enhanced unemployment benefits, we believe helped to generate the upside economic surprises noted above.

While the US has provided trillions of dollars in both fiscal and monetary stimulus, we continue to believe that more needs to be done to support the economy amid the coronavirus pandemic. We think that state and local governments in particular will need additional federal support. This would help to mitigate the tax increases and reductions of services that would otherwise take place, dampening growth, as those entities seek to balance their budgets. Federal Reserve Chairman Jerome Powell has been consistent in his message in recent months that more fiscal support is needed in this regard. Moreover, while the Federal Reserve has intimated that it is willing to take further action, it is our view that it would prefer to wait for Congress to act first. We think that the Federal Reserve is also waiting to assess the path of viral transmissions and economic growth, and possibly for the results of its formal review of monetary policy strategy, tools and communications, which could inform any additional steps it may take.

As we look ahead, we are encouraged by the spate of improving economic data. However, the pertinent issue at the moment is the sustainability of the recovery. Our primary concern over the last few months has been the potential for another surge in COVID-19 cases to an extent which would impact economic activity. With numerous states now having paused or rolled back at least certain aspects of their reopening plans, it appears that that there may be some degree of economic impact, but to what extent remains an open question. With equity markets having had a strong run during the 2nd quarter, we think that stocks are implying a steady continuation of the economic recovery, which may be overly optimistic. We also worry that politics could delay or reduce the next tranche of fiscal stimulus that is expected in late July, ahead of the expiration of enhanced unemployment benefits and before Congress’ scheduled August recess. We have therefore recently taken actions to slightly de-risk our portfolios should the resurgence of the coronavirus ultimately derail the economic improvement seen in recent months.

We note, however, that we have not yet seen much weakness in the economic data from this latest spike in coronavirus cases, and there are other factors keeping us from taking an overly defensive posture for now. These include the potential for further fiscal and monetary stimulus, which we think becomes more likely the worse the spread of the coronavirus gets. While we will let the data inform our decision making, at the moment we feel that a bifurcated approach to portfolio construction remains optimal, whereby we are maintaining exposure to early cycle holdings that we believe will do well should the recovery prove sustainable, while at the same time keeping some defensive holdings in place to help guard against potential market declines in the event that there is a pause in the economic recovery.

May 2020 | Equity Commentary

Published on May 31, 2020

May 2020 | Equity Commentary

Watch a short three minute summary of our thoughts on market activity in May.

Market Overview

Stocks moved higher during May as the S&P 500 returned about 4% for the month. While it appears economic data remained weak in absolute terms, we saw signs of improvement relative to April. Investors appear to seem optimistic that activity will continue to rebound as more states start to allow an increasing number of businesses to reopen.

There are reasons to believe that the worst of the economic damage from the coronavirus may be behind us. While the data in general remain weak in our opinion, several key indices did show improvement in May on a month-over-month basis. Examples include the NAHB homebuilder index, consumer sentiment indices from both the Conference Board and the University of Michigan, and regional Fed manufacturing surveys. The labor market too, which has seen unprecedented dislocations, may be healing. While still elevated, initial unemployment claims have been trending steadily downward over the last several weeks, and continuing claims improved for the 1st time since the job market began to deteriorate in late March. To be sure, much of the economic data remains depressed, and we expect that certain areas of the economy will remain challenged for a prolonged period. Still, we are encouraged by these improvements, particularly given that they tended to occur in metrics that we view as being more forward looking, and therefore better indicators of future activity.

We continue to believe that more fiscal stimulus is necessary to help fully repair the economy, and we think this is the consensus view among investors. Federal Reserve Chairman Powell, at a recent speech, noted that without more support a painful recession could be in store. In our view, some of the recent stock market gains have come in anticipation of more policy action, on both the fiscal and monetary fronts, and we therefore think that stocks could be at risk should politics get in the way of additional stimulus bills. In this regard we were encouraged by Senator Mitch McConell’s recent comments suggesting he agrees that more government support is needed. We will be keeping a close eye on stimulus negotiations as we believe that capital markets may be quite sensitive to them.

We continue to monitor relations between the US and China, as tensions may again be mounting, this time apparently due to the political fallout from the coronavirus. The Trump administration in recent weeks has considered mandating that the Federal Government’s Thrift Savings Plan not invest in Chinese stocks, and has also contemplated imposing further restrictions on Huawei Technologies. We are encouraged though, that President Trump has thus far avoided taking significant actions which may worsen trade relations between the two countries. We think that he is sensitive to the political consequences of further jeopardizing an already vulnerable economy by reigniting a trade war with China, particularly so close to an election. We view this situation as being somewhat analogous to late last year, when despite concerns that the administration was considering additional tariffs on Chinese goods, they ultimately were able to strike a phase I deal.

As we look ahead, we continue to see a plausible scenario whereby stocks can continue to move higher on the heels of an economic rebound. With all 50 states now having begun to ease restrictions on certain business activities, we would expect some economic improvement to follow. We also see the potential for the release of a certain amount pent-up consumer demand as more businesses reopen. In this regard we note that the savings rate is currently quite elevated, and consumer net worth appears to be near all-time highs. These conditions could bode well for a strong 2nd half recovery.

A potential resurgence of the coronavirus is a key risk factor for stocks. Evidence is already beginning to show an increase in cases in some states. We think that the market can handle an increase in new cases if it doesn’t rise to the point which would require further rounds of business closures and social distancing mandates. In this regard, we do have some concerns that the protests over the death of George Floyd and related social activity could exacerbate the spread of the coronavirus, thereby posing a risk to capital markets which we will be closely monitoring.

April 2020 | Equity Commentary

Published on May 12, 2020

April 2020 | Equity Commentary

Market Overview

Stocks rebounded in April as the S&P 500 gained over 12.5%, marking its best month since January 1987. Investors looked past dismal economic data and instead focused on the potential for improving conditions as many states took initial steps to reopen their economies and progress appears to have been made with regard to a potential coronavirus treatment. Additional rounds of fiscal and monetary stimulus also look to have buoyed investor spirits.

The US government and Federal Reserve continued to expand their various initiatives to support the economy over the last several weeks. The Federal Reserve announced that it would provide up to an additional $2.3 trillion in credit to businesses and state and local governments. This includes $600 billion for its Main Street Lending Program whereby the Federal Reserve will partner with commercial banks to provide loans to small and mid- sized businesses. In addition, Congress authorized an incremental $484 billion in fiscal stimulus, the majority of which will be allocated to its own small business lending program, which had already exhausted its initial $350 billion in funding.

There have been challenges associated with the rollout of these various programs. This is not surprising to us given the speed with which they have been implemented. Examples include certain publicly traded and/or higher profile companies which were able to access funds that were intended for smaller businesses. In our view, speed was of the essence here. The government and Federal Reserve had to act quickly in order to stave off a potential economic calamity, and we view the trade-off of a faster, yet imperfect rollout as being acceptable, all things considered. A bigger concern is that more will likely be needed in order to support states and local governments. Given the requirement that states maintain balanced budgets, massive cutbacks will likely be in store if the Federal government does not provide more financial assistance. While we understand that each additional round of government stimulus becomes more politically challenging to implement, we think the alternative of forcing states and local governments to slash budgets would be a mistake, and counterproductive towards the goal of supporting economic activity.

Economic data released during the month was, as expected, weak. Many key economic indicators experienced their largest ever recorded monthly declines, including consumer and small business confidence, and retail sales. Aggregate jobless claims spiked to an unprecedented 30 million over the six weeks ending April 25th. As a point of comparison, the four-week moving average of unemployment claims through the 1st week of March was approximately 220,000. While there were few silver linings to be found among April’s data releases, judging by the financial market’s performance during the month, investors were clearly able to look past these numbers. We believe that this was in part a function of very low expectations given that so many businesses have been forced to at least temporarily shut down or operate at reduced capacity to help slow the spread of Covid-19. Moreover, with many states having already begun to take initial steps towards reopening their economies, we believe that investors are optimistic that business activity will rebound materially over the back half of the year.

We believe the path ahead for capital markets and the economy will likely hinge on the extent to which the coronavirus continues to spread. New case numbers in many parts of the country have started to trend favorably, which gives us reason for optimism that the worst of the economic damage may already be behind us. Moreover, there has been some progress made with regard to potential coronavirus treatments and vaccines, and the FDA has been proactive in removing hurdles which would otherwise slow the potential time to market for such therapies. We are also seeing inflections in financial market indicators which suggest that the investment climate may be improving. In addition to the equity market’s strength last month, other risk metrics such as credit spreads and the volatility index have improved considerably. Finally, we note that China’s economy has begun to rebound, which should have positive implications for the US multinational corporations that do business there.

We believe a bear case would likely be a function of a resurgence of the virus, either due to states allowing businesses to reopen prematurely, or as some experts have predicted, from another wave of infections that may ensue during the fall. Under this scenario, economic activity would likely be impacted for longer than investors currently expect, and stocks could be at risk for further declines. Moreover, the material uptick in unemployment could negatively impact consumption for a prolonged period, igniting a vicious cycle whereby businesses see further declines in revenues, necessitating additional rounds of job cuts. While we would ascribe a higher probability to the upside case, we think the potential for further market declines is plausible enough to warrant a barbell approach to portfolio construction. In this regard, we have been adding to stocks that we expect would outperform in upward trending markets, but we continue to maintain sizeable allocations to more stable and defensive holdings that we believe would help to preserve capital should market conditions deteriorate.

First Quarter 2020 | Fixed Income Commentary

Published on Apr. 21, 2020

First Quarter 2020 | Fixed Income Commentary

Market Overview

The first six weeks of 2020 saw a continuation of the momentum with which the U.S. economy exited 2019, but that hardly seems relevant anymore. The spread of the novel coronavirus from China’s interior in December to a worldwide pandemic in March has upended the global economy and capital markets in unprecedented fashion. Public health efforts to stem transmission have appeared to rapidly suppress economic activity. Weekly unemployment claims have soared past prior recessionary highs. Swift financial market declines across asset classes reflect these realties. We believe the massive fiscal and monetary stimulus packages brought forth by U.S. and global authorities offer some hope of ameliorating the stark economic fallout and supporting a recovery once restrictive social distancing measures are permitted to subside. In our view, this was reflected in price appreciation off the lows in most risk assets beginning in late March.

A second blow to economic growth and financial markets occurred when two groups of nations led by Saudi Arabia and Russia struggled to agree to reduce crude oil production in response to declining demand for fuel. While the OPEC+ parties ultimately agreed to production cuts, the scale of their action appears to us insufficient, and crude prices remain at multi-decade lows, with economic impacts reverberating across the global supply chain.

Turning to the U.S. fixed income markets, quarterly performance across fixed income sub-groups reflected the impact of the pandemic and crude oil shocks. There was a flight to quality, with U.S. Treasuries and the highest quality corporate bonds acting as one of the few safe havens in this crisis period, while spreads to the weakest-rated credits widened the most. Within the U.S. corporate investment grade universe, an index of intermediate-term AA-rated bonds returned about 1.0% while A-rated bonds lost about 1.0% and BBB-rated bonds lost approximately 6.2% in the first quarter. By sector, the decline in U.S. intermediate-term investment grade corporate bonds was concentrated in the energy sector, which declined about 18.6%, and the real estate sector, which declined about 5.8%, as compared to the broader group’s approximate 3.2% decline. Notably, the financial sector held in well, declining just about 1.7%, possibly reflecting the strong capital positions of the banks heading into the crisis, as well as the reduction of claims activity expected in the insurance sector across property, casualty and health. Finally, in terms of capital structure, preferred securities underperformed corporate bonds, as investors in their flight to quality punished holdings with subordinated positions. An index consisting of fixed-rate preferred securities declined about 8.8%, and the most widely held preferred securities exchange-traded fund declined about 14.6%. In addition, fixed-to-float preferred securities generally underperformed their fixed-rate counterparts due to the decline in interest rates in the quarter.

In mid-March, during the period of steepest price declines, amidst what may have been panicked or forced selling by leveraged investors, the fixed income markets appeared to have seized, and failed to properly function. Bid and ask spreads widened, and little volume was available for purchase or sale, even at what seemed like costly quoted prices. Alarmingly, this occurred across U.S. Treasury and agency-backed mortgage securities markets, usually the most liquid markets globally, as well as the intermediate corporate bond and preferred securities markets where we typically trade. The Federal Reserve’s emergency interventions, which included outright purchases of Treasuries and agency MBS in unlimited amounts, and facilities to finance securities held by primary dealers, commercial paper, and corporate and municipal bonds, have steadily restored market function, and with it, we believe, investor confidence. When markets seized, our portfolio managers and traders tread carefully to ensure that purchases and sales on behalf of clients were transacted at or near our best estimates of fair value. Presently the Federal Reserve interventions have largely stabilized the investment grade corporate and exchange-traded preferred markets, and while the institutional, thousand-dollar preferred sector continues to face some challenges, it too appears to be gradually normalizing. In our view, it is not surprising that this market would lag in its return to normalcy, given its specialty nature and relatively short trading history.


We believe the outlook for the economy and financial markets in the near term is largely dependent on three variables. The first is the path of the virus. We continue to observe daily growth in new case counts slowing in the U.S. and other major markets. This suggests the second key variable, the speed at which public health measures may be lifted, also holds some promise. The end of the lockdown economy in the U.S. is likely to require additional testing capacity and could be further supported by the development of therapeutic interventions such as antivirals or vaccines. The final variable is the depth and breadth of the government response. The Federal Reserve has demonstrated that it will support markets during this time of turmoil. However, there is uncertainty as to the scope, timing and magnitude of additional fiscal stimulus, which may ultimately be required to support risk assets.

The downturn we are experiencing now can be deep but short-lived if public health measures and government stimulus are sufficient. It could be longer-lasting if viral transmissions rebound, political obstacles limit further stimulus, or consumer demand shortfalls push more businesses to shutter. The path forward is uncertain, and we are closely monitoring reports from public health, economic, political and financial domains to inform our evolving outlook for credit. That said, the extraordinary commitment demonstrated by the Federal Reserve to support high grade borrowers provides us with some confidence that the worst-case financial scenarios are unlikely to unfold.

March 2020 | Equity Commentary

Published on Mar. 31, 2020

March 2020 | Equity Commentary

Market Overview

Stocks had a tumultuous start to the year, as coronavirus-driven fears took the S&P 500 down about 20% for the 1stquarter. We are optimistic that fiscal and monetary stimulus programs should help to mitigate financial and economic stress. Still, we think it is likely that financial markets will remain volatile until investors gain comfort that the pandemic has begun to run its course.

Capital markets took their cues from the continuing spread of Covid-19 during the first quarter, as stocks declined and Treasury yields plunged to all-time lows. We believe investors were repricing markets to account for the increasing likelihood of recession, as large parts of the economy remain on pause due to the social distancing and other preventative measures that governments have enacted. Economists are currently forecasting mid-single digit GDP declines for the US for the 1stquarter, and much steeper drops, potentially 20% or greater for the 2ndquarter. Many economist projections are calling for a sharp rebound over the back half of the year, though we believe this will largely depend on the duration and extent to which the virus curtails business activity.

The duration of the pandemic is the key variable in our view. The longer that the virus takes to run its course, the deeper the recession is likely to be, which could start a vicious cycle whereby consumers minimize spending which further weakens businesses, leading to less corporate expenditures and hiring. However, if the social distancing measures currently in place are effective in minimizing the spread of the virus, we think a bull case scenario is possible whereby economic activity is largely back on track over the medium term.

We are encouraged by the fiscal and monetary stimulus programs which have been put in place. We think that the federal government and central bank have learned valuable lessons from the 2008 financial crisis, when in our view they could have acted sooner and more aggressively. In response to the impacts of Covid-19, the Federal Reserve quickly brought interest rates down to near zero, and enacted a litany of programs to improve the flow of credit to the economy and support liquidity in financial markets. The Federal Reserve’s unrestrained quantitative easing program is unprecedented in the history of US monetary policy, as are the newly implemented plans to make direct loans to, and purchase bonds issued by, investment grade corporations. We are already seeing the benefits of these actions as liquidity has improved materially in fixed income markets. With regards to the $2.2 trillion fiscal stimulus plan, we think direct payments and the increase in unemployment benefits will work to quickly deploy funds to consumers in need during this period when so many are at least temporarily unemployed. We also think it is crucial to support small businesses and are therefore encouraged that the fiscal package includes about $350 billion of loan guarantees via the SBA as well as almost $450 billion of funds to support Federal Reserve credit facilities, including an expected Main Street Business Lending Program for small and mid-size companies.

We caution, however, that providing relief for small businesses across the country will be no easy task. The sheer number of companies in dire need will make the logistics of disbursing loans quite challenging. Moreover, we think that the application process needs to be as simple and streamlined as possible so as not to exclude companies that do not have the time or resources to devote to filling out pages of financial questions. It is also conceivable that the amount currently allocated to support these loan guarantees will be insufficient and we would therefore not be surprised if further rounds of stimulus are required. A final note to consider is that while these stimulus programs are intended to buffer the economy, we think it is highly unlikely that they will enable it to avoid a recession. An economic contraction seems largely unavoidable at this point, though we think that its duration and magnitude will be far less severe than what would have been the case without government and central bank intervention. This potential recession could be the first in history which came about not as the result of an economic slowdown but because it was effectively mandated by the government in its efforts to slow the spread of a pandemic.

While these are challenging times to be navigating capital markets, we do not see any reason to be selling indiscriminately. Just as the stock market’s recent decline was sudden and sharp, we believe that as signs of the pandemic abating emerge, the rebound could be similarly rapid. We entered the quarter with a defensive tilt to our portfolios, which we modestly increased in early February, and we continue to believe that is a prudent way to be positioned given the inherent uncertainties in the current environment. However, we have also begun to take new positions, or add exposure to holdings of companies whose stocks have sold off with the market and that we believe are now trading at attractive prices. It is impossible to know exactly to what extent, and for how long, the pandemic will dampen economic activity. We need to be cognizant of this uncertainty while making our investment decisions, but we also believe in the resilience of the American economy, and despite the potential for more short-term volatility, we maintain our optimism on US stocks over the medium term.

This Too Shall Pass

Published on Mar. 26, 2020

This Too Shall Pass

We believe several markers are in place suggesting it may be an attractive time to invest in fixed income and equity markets, albeit in a conservative fashion. In our opinion, the financial markets have been dislocated. Prices have largely fallen considerably from where they were a month ago. Liquidity seized across fixed income markets and is only beginning to mildly thaw in the wake of massive Federal Reserve intervention. We believe that this suggests a buying opportunity, but of course these lower prices must be compared to the fundamentals of the companies.

The pandemic and the public health response have suddenly and severely curtailed demand for many goods and services. In the next few weeks, we believe that there will be massive additions to the unemployment rolls, and scenes of healthcare rationing may be streamed into our living rooms. The widening of corporate spreads and the bear market in stocks reflect these grim realities. But we believe the impact on corporate earnings will be temporary. A successful pharmaceutical intervention is possible from one of the many antiviral or antibody therapies currently being trialed. We are encouraged that social distancing will slow the spread of COVID-19, as it has in other nations. We believe that the monetary and fiscal stimulus packages are large enough to matter, though not a cure-all, and we expect to see more actions in the coming weeks. America’s collective ability to endure a “lockdown” economy has limits. We therefore expect that this too shall pass.

We believe it is important to invest where balance sheets can withstand a recession, which is why capital must be deployed conservatively. Fortunately, securities issued by many leading companies with solid finances were also marked down in this maelstrom. Our approach is not to attempt to be heroic, but instead to purchase the fixed income and equity securities of attractive issuers at discounted valuations. When the pandemic crisis abates, there will be catch-up purchasing of durable goods that were delayed in the downturn, while monetary and fiscal stimulus will not be curtailed as quickly as it was introduced. Though we do not expect a “V”-shaped recovery, we do expect a meaningful acceleration in activity off of the low prices. We believe that financial markets will anticipate this: Markets often peak while the economy is still in expansion, and they often trough while the economy is still in recession. In our view, putting some capital to work today properly anticipates this reality.

Unlimited Quantitative Easing

Published on Mar. 24, 2020

Unlimited Quantitative Easing

The Federal Reserve announced a number of actions Monday morning, several of which appear to be unprecedented. Overall, in our view, these are steps in the right direction.

The Federal Reserve expanded its authority to purchase U.S. Treasury and agency mortgage-backed securities in unlimited amounts. The Federal Reserve also added agency corporate mortgage-backed securities to this program, which are loans against multifamily housing units. It similarly broadened its Money Market Liquidity Facility to include more complex municipal debt structures that were not initially covered.

The Federal Reserve also revived the Term Asset-Backed Securities Loan Facility (TALF), a tool it used in the 2008 financial crisis. This facility lends against consumer debt including credit card, auto and student loans, as well as qualified Small Business Administration loans. This will enable banks to continue to lend to consumers, since it knows it can pledge these loans as collateral to the Federal Reserve.

To support the investment grade corporate bond market, the Federal Reserve created two new facilities: one to lend to investment grade corporate borrowers, and another to purchase investment grade corporate bonds and exchange-traded funds that hold those bonds. This is unprecedented. But we know from our own experience at Roosevelt that these markets are not functioning properly. Earlier steps to improve functioning in related fixed income markets were not enough to restore liquidity.

We believe it was appropriate to include exchange-traded funds in this program, since they are an important conduit for liquidity in this market.

We do have concerns that the TALF, corporate bond and ETF facilities may not be enough to stabilize these large markets, and therefore, we believe it is possible the Federal Reserve will have to expand these programs. As a result, we believe it may be necessary for Congress to appropriate more crisis funds for the Treasury to use as it expands these programs.

In Monday morning’s statement, the Federal Reserve alluded to a Main Street Lending facility for small and midsize businesses. We believe this facility, or something like it, will be crucial to mitigating damage to the U.S. economy during the pandemic disruption. In our opinion, such an action is best implemented via the banking system, such as through a Main Street facility, whereby the Fed accepts these loans as collateral with Treasury absorbing the losses. Congress is currently negotiating the size and form of such a package, as one of many items in its $1+ trillion stimulus bill.

The size of any stimulus bill is critical in softening the blow to the economy. We therefore expect additional Federal Reserve actions in the coming days and weeks, some in conjunction with Treasury, and others possibly by Congress.

Our Most Recent Market Thoughts

Published on Mar. 20, 2020

Our Most Recent Market Thoughts

As of Tuesday March 17, the S&P 500 has declined about 25% from its peak on February 19, and about 20% from the start of the year. Volatility is at highly elevated levels, and we’ve seen similar extremes in other financial market indicators we follow, such as the interest rate premium charged to risky borrowers, and the proportion of stocks with prices below their 200-day average. These are highly unusual times in the capital markets.

Economists and strategists are trying to determine what the impact to corporate earnings will be from the pandemic, both in terms of timing and magnitude. At this point, our best guess is that economic activity will be depressed for a quarter or two, after which a rebound is likely.

If we look back to prior pandemics over the past two decades, the stock market has already exceeded its average decline when investors grew concerned regarding the impacts of SARS, MERS, swine flu, bird flu, and Ebola. Those declines averaged about 7%, and, on average, the market rebounded to higher levels over the next six months. We believe that making this episode worse is that some industries will be impacted quite negatively by consumers curtailing their activities in ways we did not see in the past.

We believe that service-oriented industries such as restaurants, hotels, and other travel-related companies will be particularly hard hit, as conferences, athletic events and other gatherings have been cancelled. These sectors will most likely endure severe revenue impacts that may never be recouped. The damage may be limited in other areas to a near-term pause in revenue that is partially recouped in future periods. This may occur in industries such as manufacturing, transportation of goods, healthcare, and technology. Some firms may see little impact at all on their business. A lucky few may even benefit. (More on this below.)

As a result of the pandemic and the steps being taken to slow the spread of the virus, it now seems likely that the U.S. could experience a period of decline, followed by a catch-up which recoups some but not all of what was lost before. And then, perhaps a year from now, growth could revert to its prior trajectory before the pandemic struck.

Fortunately, we believe the U.S. economy entered this episode from a place of strength, with low unemployment and a consumer that on average has been confident, saving money and improving their finances. But in other parts of the world, particularly in Europe, economic growth has been far slower, and it is possible that the pressures from this pandemic will push the global economy into recession. We think that the U.S. may experience a mild recession as well, if the pandemic lasts longer than the second quarter before growth resumes. This is using the technical definition of recession, which is more than one quarter of negative growth. If recession strikes the U.S., we believe it will be short-lived.

The recent failure of OPEC and Russia to agree on oil production cutbacks, despite the pandemic’s impact on demand, has caused the price of crude oil to plummet into the $30s per barrel, a level not seen in about five years. This has added to pressures on capital markets, since many shale oil producers are not able to achieve profitability at such low prices. But we believe that the resulting lower gasoline prices will put more discretionary income in the pockets of consumers, precisely at a time when it may be most needed. A lower oil price will also help many companies achieve lower costs to the extent oil is an input, such as for transportation.

To date, we think that the global fiscal and monetary response to the pandemic has been inadequate to calm investor fears, as the lack of coordination between central banks in the U.S. and internationally has weighed on security prices and sent bond yields to record lows.

Upcoming U.S. elections may be a secondary factor impacting market volatility. The rise and subsequent fall of the Sanders campaign first weighed on and then supported the stock market. More recently the Trump administration’s missteps in managing the crisis may be weighing upon the stock market as well. Successfully dealing with this unprecedented pandemic could become an existential issue for Trump’s re-election, and reduced investor confidence in a Trump re-election may also be weighing on the market.

In similar periods in the past, we have seen that extreme volatility often marks peak pessimism; it eventually passes, and then more normal conditions return. We’ve seen this play out before, whether in the depths of the December 2018 decline, the 2016 pullback relating to the sharp decline in the price of crude oil, the summer 2011 pullback after S&P downgraded US debt, and even the financial crisis of 2008-09. Particularly after the market has experienced a sharp pullback such as we’ve experienced in these last few weeks, being too bearish at this juncture seems unwise to us.

In those past market episodes, government officials and central bankers understood that strong measures were needed to help maintain confidence in the system. As a result, the odds have increased that we may get a ‘shock and awe’ type of policy response, even though so far investors have been underwhelmed by what we have seen. There have been many proposals and half measures, but, as of yet, nothing on the scale of what will probably be needed. Though dysfunction in Washington is prolonging the process, we expect the government to eventually act as necessary, because it is in all parties’ best interests to do so.

It is also possible that some pharmaceutical solution might be discovered that is successful at treating the most difficult cases, which would be good news that could materially change the views of many investors with concerns about the pandemic’s ultimate impact. Relatedly, the spring season will be upon us soon. As we have seen with the flu each year, warmer weather tends to curtail the number of new infections. It has been theorized that the arrival of warmer spring weather could help to slow or stop the COVID-19 outbreak.

Lastly, China, South Korea and Japan are all further along in the progress of the outbreak. If we see a material downtrend in new infections being reported by those countries, it may bode well for the outcome of the pandemic and the ultimate number of cases which are reported in the U.S. This might also provide relief to investors concerned about the ultimate scale of the outbreak here.

One last thing to consider is that, at the firm level, in times of market or economic stress, the best-positioned companies often make significant gains in market share. We expect to see similar winners this time around. Consider Amazon, a company that had already moved aggressively into same-day delivery of goods, including groceries, from its Whole Foods stores as well as its Amazon Pantry offering. In addition, Amazon Web Services is one of the leading providers of cloud computing, which enables software-based services to be delivered over the Internet. As the pandemic forces retailers to close stores and office employees to work from home, consumers may purchase more goods online, and companies may rely more on the cloud. As these groups make greater use of Amazon’s services, some portion of them will discover just how easy and efficient Amazon makes their lives, and they will not return fully to prior ways of shopping and working.

Another example may be digital payments. As many of us now obsessively wash our hands and avoid contact with things we didn’t even think twice about touching a week or two ago, one thing that some now consider ‘dirty’ is cash, since it may be a means to transmit infection. As some consumers discover just how easy it is to use digital payments services, offered by companies including Apple, MasterCard, Visa and PayPal, some portion of them may shift their payment habits to digital.

Finally, as colleges and schools close down to help try and mitigate the spread of the virus, parents and students are being forced to shift to digital tools to enable online classroom learning. There are many software companies that will now be in the spotlight as demand for such products increases, as well as for hardware to enable the digital learning sessions. In China there is already a shortage of Apple’s iPads because so many parents have purchased them for their child. We may see similar trends here in the U.S. Volatility may be with us for the time to come, but we believe that this too shall pass.

Current Income Portfolio Update

Published on Mar. 20, 2020

Current Income Portfolio Update

A key economic impact of the Covid-19 pandemic is the heightened near-term probability of U.S. and global recession. Investors appear to be pricing this new reality into financial markets. It is most visible for us in the unusually volatile equity market selloff. In the fixed income markets, which primarily trade over-the-counter rather than on exchanges, the ongoing repricing of credit risk has been accompanied by a significant decline in liquidity.

In order to fulfill its mandate of promoting maximum employment, stable pricing and moderate long-term interest rates, the Federal Reserve needs U.S. fixed income markets to fully function with sufficient liquidity to act as a transmission mechanism for monetary policy. For this reason, in recent days the U.S. central bank directly intervened to attempt to restore proper market functioning. It began by offering secured lending against Treasury bills, and it then escalated into $700 billion of direct purchases of Treasury and agency mortgage-backed securities, and most recently it also purchased three-month commercial paper from highly-rated issuers, with up to $10 billion of credit losses to be covered by the U.S. Treasury. We believe these efforts will likely continue, with additional expansions if necessary, until liquidity returns to the fixed income markets.

Our management of the Current Income Portfolio (“CIP”) is affected by the present lack of liquidity in the investment-grade corporate fixed income market. We believe bid-ask levels are not reliable at this time of historical dislocation. As the Federal Reserve’s actions propagate across fixed income markets, we expect liquidity will return, with corporate bonds repricing to incorporate a higher level of credit risk, consistent with a heightened probability of a recession in the wake of the pandemic.

Our approach to purchasing and selling investment grade corporate bonds within CIP is to evaluate transactions individually. We will generally seek to trade only when the price reflects option-adjusted spreads that are consistent with historical levels and in our view appropriate for the individual corporate credit profile and security structure.

Historically there have been other episodes of credit market dislocations following rapid changes in the economic outlook, with market liquidity returning once investors gain comfort that the environment is properly incorporated into security prices. We expect this time will prove no different.

Our Thoughts On The Potential For BBB Downgrades

Published on Mar. 20, 2020

Our Thoughts On The Potential For BBB Downgrades

When credit rating agencies assign credit ratings to issuers, the credit analysts generally consider the resilience of the underlying business and that business’s ability to service its debts through a business cycle contraction. A heightened probability of recession alone may not be reason enough to prompt a wave of rating downgrades. That said, we believe every economic market cycle is different, and a sudden falloff in economic activity from a rapidly spreading pandemic is most likely not the recession case broadly modeled by credit analysts when ratings were assigned.

Industries caught in the crosshairs of the Covid-19 pandemic, and companies experiencing outsize revenue or supply chain impacts beyond a typical recessionary episode, might be vulnerable to credit ratings downgrades. This may be particularly impactful for those issuers rated BBB-, the lowest rung of investment grade, as a downgrade would catapult them into junk status. In the current situation of stress across the capital markets, investors in these bonds could see their positions materially repriced.

An important offset may be government-directed fiscal relief. Historically these types of packages have supported the creditworthiness of their recipients, and we expect the rating agencies will take this into account when determining whether an impacted company still merits a lower investment grade rating. While Congress has passed two bills thus far designed to provide relief for Americans, there are ongoing negotiations over a third larger bill which may include industry-specific bailout packages. However, we do not know at this time what form any such packages may take, and which firms they may cover.

The Current Income Portfolio mostly manages credit risk on a sector basis by largely avoiding those areas it deems weakest, consistent with seeking attractive yields while preserving investor capital. Broadly speaking this has led the portfolio to enter this episode underweight or largely unexposed to the energy and retail sectors, which struggled to overcome secular headwinds during the economic expansionary period. Its exposure to travel and automotive manufacturing is similarly limited in nature.

With respect to large banks, where CIP does have material exposure, we see several crosswinds. The benign credit conditions banks have experienced for many years appear to be coming to an end, and we expect borrower delinquencies will increase materially in the coming months. Moreover, the new current expected credit losses (CECL) accounting standard will require banks to accelerate their recognition of credit losses as the economic outlook worsens. That said, many banks enter this period holding substantial capital. We believe that they have been careful to limit lending to the energy sector following the similarly steep crude oil price declines that occurred just four years ago. Many broker-dealer businesses have experienced an uptick as clients race to hedge exposures in these volatile markets. Overall we believe large banks are well positioned to weather the storm, and we expect them to hold sufficient capital and liquidity to retain their investment-grade ratings, as these are an important source of confidence for their clients, as well as a way to access low-cost funding.

Coronavirus – Market Update

Published on Feb. 25, 2020

Coronavirus – Market Update

The stock market started out strong in 2020, but the past few days have seen significant weakness. It is our view that this is due to two primary factors. First, it appears the stock market is reacting to growing concerns about the Coronavirus epidemic in China and the increasing odds that it may become a global pandemic. We also feel the market may be responding negatively to what appear to be increasing odds that Bernie Sanders could be the Democratic nominee for this fall’s presidential elections. Sanders, a United States Senator from Vermont, is a self-avowed democratic-socialist who advocates radical change across U.S. society.

While the virus outbreak in China appears to have peaked in terms of the growth rate of new cases being reported to the World Health Organization (WHO) and the U.S. Centers for Disease Control (CDC), we are now unfortunately seeing new cases spike in other countries, such as Korea and Japan, as well as Italy. Investors appear to be increasingly concerned that the virus cannot be contained within the countries currently impacted, and that a more widespread pandemic appears likely.

Unfortunately, we know from experience that we cannot necessarily trust as accurate the data we are seeing from China. The WHO does have personnel in China, and we can only hope that its presence will shine a bright light on what is happening and push the authorities to disclose all of the available information.

Global economies have become so interdependent in terms of trade and supply chains that it is hard to envision a scenario where the Coronavirus doesn’t have a negative economic impact. As we see it, the question at this point is how quick the recovery will be. Major companies such as Apple have already said that the Chinese outbreak will cause them to miss their expected earnings for the March quarter due to the temporary closure of Chinese factories serving their supply chain. In addition, Apple’s Chinese retail stores were closed for a period of time, and some may remain closed.

With some products, it seems likely that ultimate purchase by consumers will merely be delayed. Apple’s iPhone and other iconic products would appear to fit into this category. But there are other more service-oriented purchases for which lost sales might not ever be recouped. One example of this would be the annual mobile phone conference held in Barcelona (The Mobile World Congress). Last year, over 100,000 attendees came to Barcelona for the annual conference. That is a lot of economic activity taking place over the course of about a week; think of the taxi drivers, cooks, maid and laundry staff in the hotels, waiters, etc. etc. who provided service to those conference attendees. This year, the conference was cancelled due to concerns about the potential spread of the virus, and the conference won’t be held again until 2021. Similarly, the Tokyo marathon was recently canceled except for elite class runners who will still be allowed to compete, with some 38,000 attendees being asked to stay away.

There are no simple precedents to examine for a guide as to how this may play out in terms of its market or economic impact. We have a good idea of the impact SARS had in 2003, but at that time China’s economy was far smaller in an absolute sense, and since then it has become far more integrated with the rest of the world. Our current thinking, which is subject to change, is that most of the economic impact is likely to be felt in the first quarter, and that much of the growth lost in will be recouped in subsequent quarters. So far, the number of cases in the U.S. is exceedingly low (about 35 confirmed), and a majority of the U.S. cases (21) are quarantined repatriated people who have come in on recent evacuation flights from China and Japan. Another 329 patients from the Diamond Princess cruise ship who were repatriated from Japan to the U.S. remain under quarantine, and the CDC believes some of those people are likely to come down with the virus.

The CDC recently asked labs in six U.S. cities to start testing laboratory samples from any patients with flu-like symptoms to determine whether the coronavirus may already be established in the U.S. If the virus is established in the U.S., we are concerned that we could see much more of an impact than we have to date on people avoiding large public gatherings, airline travel, restaurants, etc., and the follow-on impact upon domestic economic activity in general.

Even before this virus outbreak, global economies were experiencing significant monetary and fiscal stimulus, and the outbreak may even accelerate this sort of activity. It’s important to keep in mind that despite the scary headlines, this too will eventually pass, and our economy remains quite healthy among all developed economies globally. Interest rates and unemployment are both exceptionally low today, and inflation remains largely absent. These benign conditions should help support a continuation of the economic expansion that we’ve had since the end of the financial crisis in 2009.

We believe that the market may be in for some rough weather in the near term, as investors digest reports about the spread of the virus and its likely impact upon global economic growth. At this time we do not expect to make major changes in our investment portfolio as a result of the virus outbreak, although that could change. We believe that our portfolios have the ability to weather virus-related weakness, and we will continue to monitor developments.

Where Next?

Published on Feb. 10, 2020

Where Next?

Year-to-date, Roosevelt Investments has seen equities move sharply higher and then drop, likely due in part to the shivers of the coronavirus. Bond yields have declined, providing price performance, but the yield curve also inverted briefly. We believe that this is either a sign of economic fragility, or a mixed signal of flight to quality in an uncertain world.

While investors would love another year of continued economic growth, low inflation, and positive market returns, January appeared to include much data to both support and challenge this potential. Economic data has been good, but global and domestic challenges remain.

In the Middle East, an escalated conflict with Iran may have looked evident, then it eased off just as quickly. Meanwhile, the US and Israel proposed a new peace plan for the Palestinians, which is backed by some Arab countries. As always, this is a developing situation, overall the news of a new peace plan seems to be a move in a positive direction.

We believe China is a bigger story. While we are starting to get more clarity on the coronavirus, economists have also been marking down China’s growth. More confounding than an epidemic is contemplating how much more the world’s second largest economy might become isolated from the rest of the world.

We believe China is a bigger story. While we are starting to get more clarity on the coronavirus, economists have also been marking down China’s growth. More confounding than an epidemic is contemplating how much more the world’s second largest economy might become isolated from the rest of the world.

In the US, we saw that job creation in 2019 continued to be greater than population growth. Because of this we believe that most investors have expected that the US economy will continue along a 2% growth path for 2020. The recent “phase one” trade deal with China alleviated one of the biggest threats to domestic economic growth, as we see it. The Chinese agreed to buy soybeans and pork from the US and the US agreed not to raise tariffs on a substantial number of Chinese exports. We believe that even though the deal lacked as much progress as was needed, it set the right tone and the two countries are seemingly talking to each other.

All evidence seems to indicate that the Federal Reserve’s default position is to remain on the sidelines until glimmers of inflation appear. We think that the bond market has perplexed investors for years, as historically low rates have remained. Much of this is a global phenomenon of limited inflation coupled with aggressive central bank policies to stimulate borrowing and investing, in our opinion. Cross-border economic flows being what they are, we think that the US cannot isolate itself from these issues. Interest rates may have difficulty climbing higher for some time.

However, the path of a virus threatening global growth wasn’t in the markets’ initial 2020 calculations. Could we actually expect the Federal Reserve to ease rates? The market pressures of ten-year US Treasury yields trading on top of the effective Fed funds rate – meaning there is no slope to the yield curve – could lead to rates easing. A decision by the Federal Reserve to ease rates could depend on the breadth and duration of our global viral pandemic.

The oil market may provide some clues of an interest rate decision by the Federal Reserve, with crude prices down about 20% in the last month. While oil prices had been volatile when tensions with Iran were more obvious, we think that oil prices are also a good coincident indicator of the global economic outlook. With the Saudis apparently contemplating an output reduction, we think the signal of a rise in oil prices should be taken seriously.

However, much of this is about a virus literally passing through the system. At some point, it will. We believe that the underlying profitability of firms, an environment of low inflation, and an accommodative Federal Reserve will be seen as supportive to the economy and to market valuations.

Equity Commentary | January 2020

Published on Feb. 10, 2020

Equity Commentary | January 2020

Stocks were flat during January, as gains early in the month may have been subsequently offset by concerns over the developing coronavirus pandemic. Economists have already begun reducing first quarter GDP estimates for China as a result of work stoppages and travel restrictions implemented by the Chinese government. It is difficult to ascertain the ultimate impact that the outbreak will have on China’s economy, as well as business activity globally, but our analysis of prior epidemics may be useful in this regard. During the SARS outbreak of 2002-03, which also originated in China, the economic impact was largely contained to one quarter, and due to a rebound in subsequent quarters, Chinese GDP for the full period was largely unaffected, in our opinion. SARS did not appear to have much of an impact on US economic activity, although there was a temporary decline in certain confidence surveys.

In assessing the stock market impact of prior epidemics, including SARS, MERS, Ebola, and the avian flu, the typical pattern was an initial selloff, followed by a fairly quick recovery. However, there are a number of important differences between the current outbreak and the precedent examples. First, the Chinese economy is far larger than it was during the time of the SARS epidemic, in absolute terms and in terms of its portion of global GDP. Second, global supply chains have become tightly integrated over the past decade and China plays a key role in supplying goods to the rest of the world. Third, with the total cases of coronavirus within China now exceeding 30,000 (and growing), this outbreak is far larger than the number of known SARS cases, which was believed to be approximately 8,000. Finally, we don’t have a good read on the accuracy of the data coming from China on the extent of the outbreak. Some believe the true numbers are far higher. For these reasons it is difficult at this point to predict the ultimate economic impact of the outbreak, though we will continue to closely monitor the situation.

The phase I trade agreement between the US and China was signed during January. As part of the deal, China agreed to purchase an incremental $200 billion of US goods and services, while also committing to protect intellectual property rights and further open up its financial markets. While the majority of the tariffs imposed by the US on Chinese imports will remain in place, the tariff rate on the $120 billion of Chinese imports which were implemented in September will be halved from about 15% to 7.5%. President Trump has noted that the rest of the tariffs may be rescinded as part of a potential future phase II agreement.

Some financial analysts have been skeptical regarding the deal due to a lack of enforcement mechanisms should China not fulfill its obligations. In our view, however, the fact that the majority of the tariffs are still in place will act as a strong incentive for China to cooperate. We think the key risk to markets currently in this regard is that there now appears to be a good deal of positive investor sentiment on trade, perhaps bordering on complacency. While we are encouraged that the initial phase of an agreement is in place, we think that there are significant uncertainties regarding next steps. Little has been revealed regarding the timing and substance of a potential phase II agreement, and, given how the negotiations have played out thus far, it is conceivable that talks could again turn contentious and additional tariffs could be threatened. We are however, encouraged by the potential boost from increased Chinese purchases of US agricultural products. The domestic farm supply chain has been depressed for some time now, and we believe that a significant increase in exports to China could materially enhance the growth profile of the industry.

US economic data was mixed in January, as we saw indications that the manufacturing sector continued to struggle while much of the remainder of the economy appears to be in better shape. December’s ISM manufacturing survey was particularly weak, coming in at the lowest level since 2009. The employment and new order components of the survey also were at multi-year lows. However, more recent data has shown an improvement, along with regional Federal Reserve manufacturing surveys for January which in aggregate came in well ahead of analyst expectations. The service sector looks to be in much better shape as both the ISM and Markit’s gauges of industry activity for December exceeded expectations and came in at levels consistent with modest growth.

The housing industry also appears to be healthy, as it continues to benefit from low mortgage rates. Housing starts and existing home sales for December each bested analysts’ projections, and according to the NAHB homebuilder survey for January, prospective buyer traffic reached a high for the current economic cycle. While new and pending home sales did miss consensus expectations for December, we believe that much of the shortfall was the result of inventory constraints, as opposed to any reduction in demand. With momentum carrying over into January, we believe that 2020 is shaping up to be a good year for the housing market, and we are optimistic that this may create a tailwind for broader economic activity as well.

Fourth Quarter 2019 | Equity Commentary

Published on Jan. 28, 2020

Fourth Quarter 2019 | Equity Commentary

Stocks closed out 2019 in robust fashion with the S&P 500 gaining 8.5% for the fourth quarter. We believe that investors were encouraged by the fact the US and China announced that they have reached a phase I trade deal, as well as indications from the Federal Reserve that monetary policy will likely remain accommodative for some time. Positive economic data also helped to support stocks, and eased investor concerns that a recession may be on the horizon.

In December, the US and China announced that they appear to have reached an agreement on a phase I trade deal. While the deal has yet to be signed, expectations are that a signing will take place this month. Highlights of the agreement include increased Chinese purchases of US agricultural products. We also believe this deal requires China to end its practice of requiring foreign companies to transfer their technologies to domestic businesses in order to gain local market access. In return, the US will halve the current 15% tariff rate on about $120 billion of Chinese imported goods. We think that this is particularly noteworthy, as this would be the first time since the trade war began that the Trump administrationhas rescinded any tariffs. Also of significance, the key tranche of tariffs that were set to go into effect on December 15thwere not implemented. This would have included duties on consumer products such as cell phones and laptops which in our view could have negatively impacted US holiday sales.

While we see this initial agreement as positive for capital markets, we believe that it only reduces rather than eliminates trade-related uncertainties. There are still many unknowns regarding how and when the next phase of negotiations will play out. Moreover, certain thornier issues such as industrial subsidies remain unsettled. We would not be surprised if more tariffs are threatened during the subsequent round of talks, which could trigger further volatility for capital markets.Therefore, while we are encouraged that some progress has been made, we still think that there is plenty of work to be done before a comprehensive, lasting solution is reached.

The Federal Reserve helped to support stocks during the quarter with a rate cut in October and subsequent messaging that interest rates are unlikely to move higher any time soon. Following the Federal Open Market Committee’s (FOMC) December meeting, Chairman Powell noted that he would only support a rate hike after inflation had moved persistently and significantly higher. Similarly, the Fed’s closely watched dot plot, which depicts committee members’ interest rate projections, indicates that the FOMC does not currently anticipate raising rates at all this year. A prolonged pause would be significant, and stimulative for equities, in our view, given that the fed funds rate currently sits below core inflation. Put another way, real interest rates are negative and could remain so for some time. The Fed has also materially expanded the size of its balance sheet in recent months, which also tends to be positive for equities. With negative real rates likely to persist for an extended period and a growing Federal Reserve balance sheet, we view the current state of monetary policy as being quite accommodative.

Recent economic data have been encouraging, particularly regarding the consumer. The November employment report came in ahead of expectations with 266,000 jobs added, and estimates were revised upwards for both September and October. Moreover, the unemployment rate dropped to 3.5% which marked a low for the current economic cycle. The housing market continues to strengthen, with the preponderance of industry data coming in ahead of economist’s projections, and there are reasons to believe that the momentum will continue into the new year. Changes in mortgage rates typically impact housing with a lag, and we therefore expect that the approximate 100 basis point reduction in rates over the past year could bode well for continued strength in housing activity during 2020. Consumer sentiment also appears healthy. The University of Michigan’s latest reading topped expectations and remained near the best levels in a year.

The manufacturing sector, however, has been challenged as it has struggled with trade related uncertainties and a strong dollar. The ISM’s December manufacturing survey was weak and consistent with a contracting growth environment, though other indicators, such as Markit’s manufacturing PMI fared better. Despite this disconnect, we are encouraged that the yield curve has steepened meaningfully of late, and credit spreads have contracted. These market indicators, along with the healthy state of the consumer, suggest to us that overall the economy is in good shape. A near-term recession, which had seemed plausible up until just a few months ago, now seems less likely. We think that this perception has been a key factor in driving stocks higher.

Over the course of the 4th quarter we gradually adjusted some of our portfolio weightings to reduce the risk that a factor rotation towards more value and cyclically-oriented shares and away from higher quality and growth companies might pressure our investment performance. We incrementally reduced exposure to growth, momentum, and defensive holdings in favor of stocks with characteristics of greater cyclicality and value. Given some of the positive economic data noted above along with an accommodative Fed, we believe that the shares of companies with these characteristics may continue to perform well, particularly given that value stocks have been trading at extreme valuation discounts. We are not making a strong relative call on value and cyclicals over high quality and growth stocks, but we see the former as being valued attractively enough that given the current fundamental landscape, we wanted to reduce our underweighting in these areas.

Fourth Quarter 2019 | Fixed Income Commentary

Published on Jan. 28, 2020

Fourth Quarter 2019 | Fixed Income Commentary

During the fourth quarter of 2019, the investment grade intermediate term corporate bond market continued its positive momentum and returned about 1.1% to close out the year up approximately 10.2%. Similarly, the investment grade preferred stock market returned about 2% in the fourth quarter and approximately 17% for the full year. We believe that performance across fixed income markets was mostly driven by a decline in investment grade credit spreads and US Treasury yields as well as continued support from the persistent global demand for positive yield.

In our opinion, the Federal Reserve’s decision to reverse course earlier this year and take more accommodative monetary policy actions was responsible for the narrowing in credit spreads and decline in bond yields during 2019. After cutting its benchmark interest rate by 50 bps in the third quarter, the Federal Reserve made the decision to cut rates another 25 bps in October as well as restart asset purchases for balance sheet expansion. We believe that helping guide market participates into believing there would be no further interest rate hikes was Federal Reserve Chairman Powell’s comments in the latest Federal Reserve Minutes regarding no hikes until inflation was “persistently” and “significantly” above currentlevels and closer to its 2% target. The policy shift came after we saw synchronized global growth deceleration which we believe was caused by trade war headlines, uncertainties around Brexit, and global manufacturing sector weakness. In effect, the Federal Reserve curbed recessionary fears by re-igniting stimulus in order to sustain the U.S. economy’s tenth consecutive year of economic expansion.

The impact of the Fed’s actions is apparent to us through various reports of economic data that came in above expectations at the end of the year. Namely, the unemployment rate reached its lowest level in the past 50 years, housing data surprised to the upside, and consumer sentiment, as reported by the University of Michigan Surveys of Consumers, remains healthy. Moreover, as the U.S. is a consumer-driven economy it has thus far been resilient to the global manufacturing weakness happening elsewhere. We believe that these factors are all supportive for credit spreads, US Treasury yields, and thus bond prices in the near future.

While we do not expect a repeat of the double-digit returns experienced in 2019, our general view remains constructive for fixed income markets to continue to perform well going forward. We are less concerned about a magnified economic deceleration occurring in the U.S. in 2020 and believe current investment grade corporate fundamentals remain quite robust. Therefore, our positive outlook for 2020 is derived from the strength of investment grade corporate fundamentals, the Federal Reserve’s commitment to accommodative monetary policy for as long as necessary to sustain the current economic expansion, and the continued demand for positive yield from both international and domestic markets.

Equity Commentary | November 2019

Published on Dec. 16, 2019

Equity Commentary | November 2019

Trade talks between the US and China continued to make headlines during November. China took several steps which encouraged investors that the likelihood of a near-term deal could be moving higher. These included raising penalties for intellectual property theft and making efforts to restrict sales of fentanyl into the US, thereby addressing two of President Trump’s concerns. Moreover, investor fears regarding any trade related blowback resulting from the Trump administration’s support of Hong Kong protestors were assuaged when China’s government announced that it would retaliate by sanctioning certain human rights organizations, as opposed to taking any actions that would directly affect trade talks.

Still, markets turned negative after President Trump announced at the recently completed NATO summit that a US-China trade deal might have to wait until after next year’s presidential election. We think that much of November’s stock market appreciation was driven by encouraging media reports earlier in the month that a phase I deal was nearing completion. This is based on our observation that trade- sensitive names did well, as did more volatile, global and cyclical stocks, perhaps implying that investors were making a bet that a successful trade deal would boost the manufacturing sector. We therefore expect that stocks would be at risk of at least retracing November’s gains should a trade deal fail to materialize.

In our view, the pending December 15th tranche of tariffs is the most important near-term issue pertaining to the trade negotiations. We think that stocks could weaken should the US impose additional import tariffs during the holiday sales period. That said, we believe that President Trump is quite sensitive to the stock market as well as economic activity, and therefore think it is more likely than not that this deadline will be pushed back should a deal not be reached by then.

Economic data has been mixed of late. The housing market continues to look robust, with new home sales for the combined September-October period coming in at the best pace in 12 years. Consumer sentiment, while off its recent peak, remains at healthy levels, and the latest reading of 3rd quarter GDP was revised modestly higher. The manufacturing sector, however, remains challenged. Industrial production declined by 0.8% during October, coming in below expectations, and the November ISM manufacturing survey remained at a level consistent with contraction for the sector. We think that this area of the economy continues to be hampered by trade tensions and the strong US dollar. Overall, we are encouraged that during the course of the year job creation and wage growth have been healthy, and with the appreciation in both stock prices and the housing market, we think that the holiday season could be a strong one. In this regard the early returns have been encouraging, with both Black Friday and Cyber Monday notching robust gains.

President Trump recently announced his intention to levy tariffs on certain French imports as well as Brazilian and Argentinian steel and aluminum products. The former is apparently in retaliation to France’s digital service tax on US companies, and the latter apparently in response to currency devaluations. While we do not think that these actions, in and of themselves, are material to the US economy, we do believe that they foster an uncertain business climate, creating challenges for both corporate executives and investors. We are therefore continuing to monitor these developments, as well as any other trade related issues that could impact capital markets, including Brexit, with an important UK election scheduled for December 12. Here at home, President Trump’s impeachment inquiry continues to dominate the headlines, though we maintain our view that this is unlikely to become an issue that will materially impact stocks.

Equity Commentary | October 2019

Published on Nov. 12, 2019

Equity Commentary | October 2019

Stocks hit record highs during October, as optimism grew that the US and China were progressing towards the first phase of a trade agreement, and economic data firmed. Investors were also encouraged by the Federal Reserve, which cut interest rates and signaled that monetary policy will likely remain stimulative for the foreseeable future.

There was some progress on the trade front during October. The Trump administration held off on a planned tariff hike on Chinese imports as the two countries moved closer to reaching an agreement in principle on a phase I trade deal. In exchange for tariff relief, China is expected to significantly increase its purchases of US agricultural products and will also accelerate the opening of its finance sector. While the deal still needs to be signed and formalized, we view this preliminary agreement as a positive indication, and it was likely a key factor in boosting stocks during October. However, we think that this is only a first step, and that much work needs to be done in order to resolve thornier issues such as intellectual property protections. Moreover, we think it is unlikely that any substantial progress will be made beyond this phase I of the trade agreement until after the US elections next November.

Following a lackluster 3rd quarter for economic growth, there are reasons to believe that fundamentals may be improving. The Institute for Supply Management’s (ISM) October non-manufacturing survey came in ahead of expectations and marked an improvement from September’s reading. Consumer confidence remains at healthy levels and the housing market continues to strengthen. The latest reading on the labor market was also encouraging, as the 128,000 jobs created during October exceeded investor expectations despite being dragged down by the GM strike. Further confirming these green shoots are market indicators such as the yield curve which has steepened meaningfully of late. Perhaps as a result of these positive trends, many of the economic forecasts that we track have lowered their near-term recession probabilities from approximately 50% just a couple of months ago, to 25% today.

We think that corporate earnings have also given investors reasons for optimism. Profits were expected to fall sequentially for the 3rd quarter, but aggregate earnings have exceeded forecasts to the extent that it now appears they will show positive growth on a quarter-over-quarter basis. Perhaps even more importantly, forward earnings estimates for the S&P 500 have been moving higher. While certain sectors, such as energy and manufacturing remain challenged, we believe that these issues have been contained and do not appear to be dragging down the broader economy.

As was widely expected, the Federal Reserve cut interest rates by 25 basis points at its October meeting. The FOMC (Federal Open Market Committee) signaled in its prepared statement that it expects to be on hold with regards to further interest rate moves for the foreseeable future. This marked a notable change, as prior to this the Fed had been preparing investors for further rate reductions. The central bank suggested its policy stance is appropriate for as long as its baseline views about growth and inflation remain intact, which we believe creates a high bar for the next policy shift. What is most significant in our view is that the Fed funds rate is currently below the inflation rate, or put another way, real interest rates are negative. Negative real rates tend to be a stimulative factor for the economy, so while the Fed may be on hold for the time being, monetary policy remains quite accommodative and will likely continue to be so for an extended period. The central bank has also resumed its balance sheet expansion, which on the margin should provide additional stimulus. We think that it was this confluence of improving economic data, thawing trade tensions with China, and a supportive Federal Reserve which has buoyed investor spirits and helped propel stocks to record highs during October.

Third Quarter 2019 Equity Commentary

Published on Oct. 21, 2019

Third Quarter 2019 Equity Commentary

Stocks moved higher during the 3rd quarter, as the S&P 500 returned just over 1% for the period. Though modest in absolute terms, these gains were generated amid heightened political and geopolitical tensions, and uneven economic conditions both in the US and abroad. While we think that risks remain elevated, there are reasons to believe that stocks may continue to be resilient moving forward.

The announcement of the formal impeachment inquiry against President Trump may have been the biggest global news story of the 3rd quarter, although we do not necessarily expect that this will have an outsized impact on capital markets. While the sample size is quite limited, historically presidential impeachments have not derailed stocks. Moreover, while the odds of impeachment by the House of Representatives do appear to be rising, we do not expect that the Senate, with its Republican majority, would convict and remove the president from office. Nonetheless, this does appear to be a very fluid situation, and it is certainly possible that new information may come out which could change this calculus.

We think that any impeachment related impact to the stock market would most likely result from the effect that the hearing could have on Trump’s re-election prospects. If it were to hurt his campaign and raise the odds of an ostensibly less business-friendly Democratic candidate, we think stocks could have some downside. However, some political pundits are making the case that an impeachment could actually help President Trump’s re-election campaign, insofar as the hearings re-energize his base. While that remains to be seen, our initial analysis is that an impeachment is unlikely to be a major headwind for capital markets.

Geopolitical tensions were elevated during the quarter, particularly in the Middle East, after the attack on Saudi Arabia’s 2nd largest oil field and largest crude processing plant. The damage initially took out about half of the country’s oil production, though most of it was back online in relatively short order. While crude prices surged on the news, they have since subsided to the point where they are now modestly below the levels preceding the attack.

In our view, it is noteworthy that the incident did not have more of an impact on global markets. We believe that had this occurred several years ago, it likely would have led to much higher oil prices, and we think that this reflects a couple of factors. From a cyclical perspective, the slowing global economy likely mitigated a sharper, longer lasting spike in energy prices. Perhaps more significant though is the secular change in oil production, where the US has now emerged as the swing supplier of crude rather than Saudi Arabia. As a result, it may be the case that future geopolitical incidents in the Middle East have less of an impact on energy markets than they have had in the past.

The trade war between the US and China continued to be a focal point for investors as both countries announced their intentions to levy additional tariffs during the 3rd quarter. However, over the last few weeks there have been some encouraging signs. Chinese companies have made material purchases of US pork and soybeans, and President Trump temporarily delayed the implementation of a tranche of tariffs that were set to go into effect on October 1st. While the delay is only for two weeks to October 15th, it still appears to be a modest gesture of goodwill and it allows for continuing negotiations in the interim. The situation remains fluid and highly difficult to predict, but the fact that the economic growth in both China and the US appears to be slowing may create a greater sense of urgency on both sides to get a deal done, which would likely be well received by capital markets worldwide.

Turning to the US economy, the manufacturing sector continues to struggle. The Institute for Supply Management’s manufacturing survey fell below 50 for the first time in recent years in August, and the index deteriorated further in September. The GM strike and Boeing’s challenges with its 737 Max are company-specific factors which may be contributing to this weakness, though more generally it’s likely that the slowing global economy, the trade war with China, and the strong dollar have been the most significant industry headwinds. There have been some bright spots though. Housing appears to be gaining momentum as recent releases on starts, existing and new home sales, and pending home sales have all exceeded analysts’ expectations. Moreover, the service sector appears to be holding up relatively well. Given its far larger contribution to GDP, this appears to have helped the overall economy continue to grow despite the weakness in manufacturing.

Third Quarter 2019 Fixed Income Commentary

Published on Oct. 16, 2019

Third Quarter 2019 Fixed Income Commentary

Thoughts from our Domestic Fixed Income Team

U.S. fixed Income markets rose for the third consecutive quarter; with the ICE BofA U.S. 1-10 YR Intermediate Corporate Index up 1.81%, the ICE BofA U.S. 1-10 YR Treasury and Agency Index up 1.15%, and the ICE BofA U.S. Fixed Rate Preferred Securities Index up 3.05% as a result of a decline in overall US Treasury yields, the yield curve flattening and investment grade credit spreads ending the quarter in line with where they started.

We believe that the majority of the third quarter’s performance was driven by the decline of U.S. Treasury rates, with yields on intermediate and long-term maturity securities experiencing a greater decline than the yield on respective shorter-term securities, effectively causing the yield curve to flatten. This phenomenon, called a bull flattener, drove the prices of longer duration assets significantly higher. Moreover, investment grade credit spreads ended the quarter in line with where they started, only temporarily widening by as much as 15bps during the mid-August market volatility, and signaling to the market that the brief inversion in the 2-10 year segment of the curve was not signaling a recession.

Macro drivers which are closely monitored by the team include the Federal Reserve’s monetary policy actions as well as early signals of potential recession; among the latter we are constantly measuring deflationary versus inflationary risks as well as where to find incremental spread/yield in an environment that continues to decline towards lower and lower nominal and real yields.


In general, we are sanguine that the US offers a “Goldilocks Environment” for fixed income investors, in that the economy is neither too hot nor too cold, and that the nominally higher yield environment in the US versus the rest of the world should continue to support stable if not rising fixed income prices.

Apparent signs of global manufacturing deceleration (predominantly in China and Germany) led the U.S. Federal Reserve to join other central banks around the world in adopting an accommodative monetary policy, as the committee voted to reduce the Federal Funds interest rate by 25bps at each of the July and September FOMC meetings this year. This contributed to the brief yield curve inversion in the 2-10 year maturities, leading to widespread concerns that the U.S. economy was decelerating meaningfully.

While manufacturing statistics are a widely watched set of leading economic barometers, the manufacturing segment of the US economy is getting smaller every year relative to the services segment of the economy (manufacturing is now less than 15% of GDP). The services side of the economy, where consumer spending resides, has not slowed to levels which in our view would pose a problem.

Other signs of economic vitality were evidenced by recent data indicating that building permits, housing starts, and home sales began to improve. This was likely driven by lower rates leading to lower refinancing and mortgage rates, coupled by strong employment conditions in areas of the US economy outside of the manufacturing sector. Also helping to support the expansion are the elevated levels of consumer sentiment that we believe are needed if consumers are going to continue to spend.

Lastly, the Fed is set to resume balance sheet expansion later this month and may reduce its benchmark rate at least one more time before year end. In this environment, the path of least resistance is up and therein lies the goldilocks situation for fixed income investors; meaning the economy is not too hot and not too cold and that the nominally higher yield environment in the U.S. versus the rest of the world (with predominantly negative yields) should continue to support stable if not rising fixed income prices.

Roosevelt’s CIP portfolio is constructed to attempt to balance the exposure to interest rate and credit risk while maintaining high coupon income and principal preservation. The portfolio’s duration is managed to be intermediate in length, so as not to leverage exposure to a particular segment of the curve. As a result, our portfolio may experience less price volatility from moves in interest rates both up or down, since our laddered approach typically spreads out interest rate sensitivities for our corporate bond sleeve.

We believe that the CIP preferred sleeve becomes increasingly important in a low nominal interest rate environment. Preferred securities of investment grade companies can significantly enhance yield without taking on significant credit risk in order to do so. This helps provide a balanced approach to producing attractive amounts of current income in a world where, in many countries, negative interest rates have become the new normal.

Slowdowns and Showdowns

Published on Oct. 8, 2019

Slowdowns and Showdowns

Economic data and corporate profitability both seem to indicate that a lower growth rate may lie ahead for 2020, while a number of major, but non-market, events could be setting us up for a period of heightened uncertainty. This low-growth period could be accompanied by increased volatility, both widening the potential range of outcomes as well as the probability of outlier events.

In economic data, recent measures of the outlook for both manufacturing and service industries appear to show weaker patterns in recent months, which if they persist could indicate about a 1.5% GDP growth rate for the next year. That compares with approximately 2.9% in 2018 and perhaps a run rate of about 2% this year.

Complicating the economic story in our opinion are global and political tensions. At the top of any list is the ongoing US-China trade tensions. Regardless of merit (and few in the West doubt the veracity of US concerns over intellectual property rights in the trade talks), we do not expect any immediate progress on trade. The US is in a somewhat of a bind here and there is no likely escape. Mostly this is likely because the mood in China is not one for concessions. To the extent that US demands include Chinese policy toward Hong Kong, Beijing is not ready to negotiate, as it considers this an internal matter. Further, the Chinese may have decided that the US is currently a capricious and unpredictable negotiator, and they may be simply waiting for the presidential election results.

At the same time, the pressure exerted on China by Hong Kong is existential and, in Beijing’s eyes, must be suppressed. While this plays out, a smaller level of exports to the US is likely seen as a small price to pay. Meanwhile, we believe that the Chinese will let the domestic policy stimulus they have put into effect over the last year take its course.

The US is not only fully amidst a presidential campaign, with all the noise that generates, but the House of Representatives is actively seeking to remove the current occupant of 1600 Pennsylvania Avenue. This could mean 13 months (or more) of chaotic uncertainty.

In our opinion asset values will be supported by a Federal Reserve that sees the economy as being in a “good place”. Certainly, Fed Chair Powell’s comment to this effect was justified, as it was delivered on the same day the unemployment rate was announced at about 3.5%, the lowest in 50 years. Powell went on to say that “[the Fed’s] job is to keep [the economy] there as long as possible”, which sets up their task in the not too distant future to lower interest rates again. This is what the markets expect, and such a move will likely be supportive of both bond and equity prices.

Equity Commentary | August 2019

Published on Sep. 18, 2019

Equity Commentary | August 2019

The trade war between the US and China continued to be a focal point for capital markets during August. Early in the month, the Treasury Department formally labeled China a currency manipulator in response to the yuan’s recent depreciation. We believe that the act of formally labeling China a currency manipulator is largely a symbolic one, reflective of the deteriorating relations between the two countries, but of little consequence to the global economy or capital markets.

More significant, in our view, are the new tariffs that were announced by both countries over the last few weeks. In response to an earlier threat from President Trump for additional tariffs on Chinese imported goods, China announced their intention to levy about 5-10% tariffs on an incremental $75 billion of US imports. President Trump responded to China’s retaliation by increasing the current tariff rate on Chinese imports into the US by 5 percentage points. Similarly, tariffs on Chinese imports that had been scheduled to go into effect on December 15th at 10% are now planned to be levied at 15%. President Trump also sent out a tweet in which he appeared to order US companies to begin looking for alternatives to doing business with China. While this call to action is not a legally binding mandate, we believe it is another indication that the US-China trade dispute could persist for some time. We do expect a fluid back and forth of trade dispute news between the two countries until a compromise is made.

While we believe that much of the news on the trade war has been negative in recent weeks, there have been some positive indications. We note that some of the tariffs that were scheduled to go into effect on Chinese imported goods on Sept. 1st have been pushed out to Dec. 15th. These include consumer products such as cell phones, laptops, video game consoles, clothing and footwear. We would not be surprised to see these tariffs delayed again as we get closer to the holiday season. These products make up a significant portion of holiday sales and we therefore think it is likely that the administration will ultimately wait until the holiday shopping season is over before levying tariffs on these goods. Both China and the US have made additional conciliatory moves ahead of the scheduled trade meeting in October, and Chinese officials have suggested putting national security issues on a separate track so that other issues might have a better shot at being resolved. Finally, the deadline for the US decision on whether to allow domestic companies to supply certain technologies to Huawei has been extended for an additional three months. In the interim, US companies will continue to work with Huawei, which presumably should please the Chinese government and perhaps ease negotiations between the two countries.

Turning to the economy, activity appears to be slowing in the US. The Institute for Supply Management’s widely followed manufacturing survey missed estimates in August and came in below 50 for the 1st time in recent years, a level consistent with contraction in the sector. The University of Michigan’s consumer sentiment index also weakened in August, and its forward-looking expectations component showed a decline from the prior month’s survey. While the Conference Board’s measure of consumer confidence remained strong, in our opinion, its expectations component weakened. We think that the inherent uncertainty of the trade war has had a negative impact on these metrics. In our view, this has created a challenging environment for corporate executives and may be impacting investment and hiring decisions, although as of yet there is little evidence of weakness in the employment statistics we monitor. While the consumer has thus far been resilient, we have concerns that the sentiment indicators noted above may be flagging problems ahead for this all-important sector of the economy.

In addition to uneven data, some investors are pointing to the recent inversion of the yield curve as further evidence that the economic expansion may be nearing its cyclical end. We think that there are cogent arguments being made on both sides of this debate. When comparing 10-year Treasuries to 2-year notes, the spread is flat, while the 10-year Treasury spread to the Federal Funds rate is inverted, and therefore we think that it perhaps paints a more ominous picture of where the economy is heading. However, with the Fed and other major central banks having injected copious amounts of liquidity into the financial system in recent years, we think it is fair to question whether the yield curve has been distorted to the point where it is no longer a reliable recession indicator. In our view it remains to be seen how much predictive power the yield curve has in the current cycle, but we do believe that the flattening and inversions seen recently may have an influence on confidence and lending, which in turn can have a meaningful impact on economic activity.

Keeping Cool in a Hot August

Published on Aug. 16, 2019

Keeping Cool in a Hot August

Trade battles, volatile equity markets, ten-year US Treasury yield flirting with the yield of the two-year Treasury and briefly inverting, and other scary headlines. What to make of it, particularly the inverted yield curve talk?

The inversion of the yield curve is said to be a marker of pending recession. While that may be true, it’s only one signal and there are a number of considerations that must be weighed.

The front end of the curve is pricing in further reductions in interest rates by the Federal Reserve. The back end of the curve has other factors driving it, which include low to negative interest rates in other markets, making the US rates look relatively enticing, and a benign inflation outlook. Bonds have also attracted safe-haven buyers, driving down yields, in the face of equity market volatility. Yes, there are tensions. Yes, there is a trade war, and global growth is slowing. Germany and China are leading examples, but none of this is necessarily a marker of pending recession in the US.

While our manufacturing data has deteriorated, the consumer, 75% of the economy, continues to roll along. Low levels of unemployment accompanied by good wage growth have produced high levels of consumer confidence. It seems that when times are good, the consumer goes shopping. When times are not so good, a shopping trip makes people feel better. Consumers consume! And reflecting the strong consumer, we think US GDP should probably be in the range of 2% for the next 12 months. We’ll be continuing to monitor consumer confidence as a key support factor for our economy in the coming months.

What typically causes recessions is either loss of access to credit or a pullback in risk-taking behavior. Credit is still available and flowing from banks and other financial institutions. Further, incidences of stress, distress, and defaults are not spiking up, which would be a typical precursor for banks and markets to begin to withdraw credit availability. Pullbacks in risk-taking typically have a behavioral element. Certainly, the world, and markets, are flush with risks and uncertainties, perhaps more in recent weeks than earlier in the year. In past cycles consumers and corporate management teams have been occasionally inclined to pull back on their spending in response to heightened periods of uncertainty and its negative impact on confidence levels. For now, we don’t see this playing out to the degree that would result in a recession. FDR would say that “all we have to fear is fear itself.”

Who’s Driving?

Published on Aug. 13, 2019

Who’s Driving?

Amid the recent market volatility, driven by what we believe are trade and currency wars, there appears to be an important and ongoing struggle for leadership in interest rate policy. Three contenders apparently vie for the controls. Fed Chair Jay Powell and the FOMC have nominal jurisdiction. However, the current political administration may have undue influence and the bond market is also in the running.

We believe that this matters perhaps because when the Fed lost control of fight against inflation in the 1970s, after getting itself pushed around by others, it took a decade plus some extraordinary measures before its credibility was restored. Since then, the Fed’s inflation fighting credentials have remained intact. Now the question we ask is, if rate policy is an instrument of growth and price level control, or if it is instead a “put” on financial markets or even an instrument for leverage in trade policy.

After some fits and starts by the Fed in 2015 and 2016 to remove the zero interest rate policies, it appeared that the markets were accepting of some nine interest rate increases. Last summer, the Fed seemed on a pathway to moving short-term interest rates towards 3%. The Fed forecasts all went to that number. But in October the markets pitched what appeared to be a hissy fit. Equity prices declined, though the Fed carried on with a rate increase in December to the 2.25% – 2.50% range for Fed funds.

By January of this year, the Fed shifted gears, declaring that rates were near neutral and it would be “patient” going forward. We think this was the signal that rate increases should not be the presumption. The markets pressed their views, pricing in various amounts of easing over 2019 and the Fed responded saying that risks related to trade uncertainty had heightened. Perhaps the easing at the July meeting was simply the Fed taking out insurance, but we believe it had little choice. A rate cut was largely expected and we feel that the markets would have clobbered the Fed with a stunning equity drop vote of no confidence had it failed to deliver.

An important question to us is whether this behavior repeats itself. Is the Fed following the markets? There appears to be a further 25 basis point reduction in rates priced into the September meeting, plus perhaps more for October and maybe a 50-50 chance for December. We believe that the markets seem to not be satisfied with just one reduction. Is the Fed’s easing path really going to be this dovish?

We believe that there is another source of pressure entirely: for some time now, the administration has been pointing to overly-tight monetary policy as slowing down the economy. Clearly the ability to press hard in China trade negotiations depends on the continued strength of the US economy. If trade talks are souring the economy, and we feel there’s more than anecdotal evidence of this, then easier monetary policy could limit some of the damage. Whether it wants to be or not, we think the Fed is deeply involved in the calculus of this equation. A weaker economy would give the administration little negotiating leverage.

In the end, the Fed may go a long way in justifying its actions around absent inflation. We think that in its mind, there should be more inflation. The disappearance of inflation baffles the Fed and it desires a bit more of it than we have. Lower policy rates, satisfying the two constituencies above, can be justified as long as inflation remains at bay. We believe that this gives the markets their desirous adrenaline fix and the administration the wherewithal to continue to the trade war one-upmanship with the Chinese.

The Fed Restocks the Punchbowl

Published on Jul. 30, 2019

The Fed Restocks the Punchbowl

If increasing interest rates is an action the Federal Open Market Committee (FOMC) undergoes seeking to reduce economic enthusiasm, especially to prevent the economy from overheating, then a rate cut is about keeping the party going.

And that’s what we have. Never mind that first half real GDP exceeded 2.5% (above the Fed’s forecast of 2.1% for the entire year) and that the health of the consumer and related spending impact upon the economy in recent months has been sound. Some recent data point to the potential for a solid second half as well. We’ll be interested in the Fed’s forward-looking language when they make their announcement. We doubt the Fed would explicitly set up the markets for continued easing, but their view on this is what we want to hear about.

It appears the Fed is looking out for the risks to the economy in making this insurance rate reduction. In our view, there are basically three risks.

First, the rest of the world is slowing or simply has no traction. While the U.S. consumer appears to be in good shape based upon consumer confidence, very low unemployment, and solid wage growth, other areas of our economy relating to manufacturing, exports, and housing have been weaker, and related data have been softer. Second, inflation remains stubbornly below the Fed’s 2% target. Last, trade policy is in flux, with significant risks of its own. These first two concerns are important markers for the Fed. The Fed does not want US policy to drift too far from the policies in the rest of the world, where central banks are also easing policy. The inflation story remains the Fed’s conundrum, they want to avoid disinflationary spirals. The Fed’s favorite inflation gauge, the core personal consumption expenditures measure (PCE), was 1.5% for the first half of the year. If inflation stays muted and if the economy falters, the Fed doesn’t have too much room to maneuver, but given four interest rate increases last year, the Fed has some.

For the Fed, the thinking is probably that any downside risks connected to uncertainty over global trade and a soft world-wide economic outlook could drag down US growth. At this point, the cost of easing policy is limited because inflation remains below target. It could be the case that an “insurance” cut is in order, after which the Fed will wait and see what the future holds with respect to the U.S. economy. This appears to be the market’s current expectation.

Second Quarter 2019 Fixed Income Commentary

Published on Jul. 22, 2019

Second Quarter 2019 Fixed Income Commentary

Fixed income markets in the U.S. posted a second consecutive quarter of gains to close out the first half of 2019 with positive performance. During the second quarter the ICE BofA U.S. 1-10 YR Intermediate Corporate Index was up 3.13%. The ICE BofA U.S. 1-10 YR Treasury and Agency Index and the ICE BofA U.S. Fixed Rate Preferred Securities Index were up 2.30% and 3.02%, respectively for the quarter.

April kicked off the quarter with relatively sanguine market conditions, as concerns over U. S. and China trade tensions and an economic slowdown remained subdued as the S&P hit new all-time highs. Moreover, Fed Chairman Powell in early May said that the Fed remained less concerned with downside risks from a slowdown in global economic activity and more confident in meeting their near-term inflation targets. This was supported by March retail sales and light auto vehicle sales data which came in better than expectations.

During the month of May, however, U.S. trade tensions heated up; this time not only with China but with Mexico as well. Uncertainties regarding a global manufacturing slowdown induced recessionary fears which we believe drove equity markets down and investment grade spreads wider. Almost immediately upon seeing the weaker economic data, the Fed reacted and hinted its intent to support the US economy as it has done for many years. The “Fed Put”, the need to provide accommodative policy, was once again pulled out of the Fed’s toolbox and markets rallied in relief.

The larger global issue that is likely to keep U.S. rates low is the fact that an increasing percentage of global bonds have negative yields. What this means is that if an investor buys a Swiss bond or a German bond for example, if they expect to hold it until maturity, they will lock in certain capital losses. This global dearth of bonds with real positive yield will in our opinion, lead to continued demand for U.S. dollar-denominated fixed income assets, despite the fact that the U.S. deficit is expanding. It boils down to the simple argument that the U.S. is the best house in an increasingly bad yield neighborhood. This is not a new issue in international fixed income markets but it is getting to the point where global consultants and major international pension funds are being forced to reconsider their local bond allocations and are increasingly looking for alternatives away from home.

Roosevelt’s CIP portfolio is designed to protect capital while delivering more attractive yield than cash. Importantly, we remain committed to our capital preservation objective in a manner designed to maintain liquidity and relatively attractive yields in an environment where yield is becoming increasingly rare.

The duration of the portfolio has been structured to be intermediate in nature, and we seek to enhance the yield of the overall portfolio through the addition of investments in companies that have issued preferred securities with attractive yields. We maintain that this market segment remains a beneficial portfolio diversifier for income-oriented investors to own in addition to bonds. In addition, aggregate portfolio yield characteristics may be improved over time through adjusting the preferred security allocation and by alternating the mix of security structures within the investor’s portfolio mix.

After starting 2019 with a lighter than usual preferred security allocation, during the quarter we took advantage of depressed market prices and raised our allocation to, for us, a more traditional 25%. At the same time, the distribution of preferred security structures in the CIP portfolio steadily increased to about 50% invested in fixed-to-float structures. We believe these types of securities work well in our style because they add to the portfolio’s overall yield characteristic, but do not add to interest rate risks beyond a traditional intermediate-term bond portfolio.

Second Quarter 2019 Equity Commentary

Published on Jul. 15, 2019

Second Quarter 2019 Equity Commentary

Stocks closed out the 2nd quarter in robust fashion, lifting the S&P 500 to about a 4.3% gain for the period. Investors were encouraged by the resumption of trade negotiations between the US and China. While we believe a decelerating global growth profile may present challenges for markets, central banks are doing their part in order to help stimulate economic activity.

The trade war between the US and China continued to be a focal point for investors during the 2nd quarter. Circumstances appeared to be deteriorating in recent weeks after the Trump administration put Huawei and a handful of other Chinese companies on an export blacklist. However, at the recently completed G20 summit, the two countries agreed to resume negotiations and forestall any further tariffs. Huawei was granted exceptions which will enable the company access to certain US technologies, and in a show of good faith China will resume purchasing American agricultural goods. While it remains to be seen whether a successful trade agreement will ultimately be reached, things appear to be moving in a favorable direction, at least for the moment.

We believe recent datapoints appear to confirm that global economic conditions are weakening. Surveys of both the Chinese and European manufacturing sectors have been flagging in recent months. Markit, which conducts purchasing manager surveys, noted that its measure of European economic optimism is at its lowest level since 2014. While we have been concerned with international economic conditions for some time now, it appears that domestic growth may also be weakening. After a 1st quarter which saw GDP growth in the US surpass 3%, consensus estimates are projecting a 2nd quarter deceleration with most forecasts in the 1-2% range. While the service sector appears to be holding up relatively well, manufacturing has been somewhat challenged, perhaps due to increased uncertainty related to tariffs and trade. The June manufacturing PMI decelerated to 50.1, a level indicative of stagnating growth. The June composite PMI, which aggregates the service and manufacturing sectors, came in at just 50.6, its weakest reading in over three years.

As a result of these uneven economic conditions, central banks around the world are becoming increasingly dovish. In its latest meeting, the Federal Reserve acknowledged various issues including U.S.-China trade uncertainties, feeble inflation, and soft international markets. Fed Chairman Powell noted that many FOMC members now see a stronger case for easing policy. We believe that many investors were already anticipating multiple rate cuts during the 2nd half of the year, and it now appears that the Fed’s view is more closely aligned with these market expectations.

The European Central bank has already taken stimulative action with the latest round of its TLTRO (targeted long-term refinancing operations) program attempting to spur lending across the region. While we are optimistic that central banks are taking steps towards shoring up their respective economies, global growth remains a key risk factor in our view. In addition to monetary policy, we think that a successful trade agreement between the US and China would go a long way towards improving global economic sentiment and business conditions.

We have recently implemented two new themes into our portfolios, ‘5G’ and ‘Cannabis’. We believe 5G, the next generation of wireless communication standards, is a game-changer. It offers the potential for much faster speeds, higher throughput, lower latency, and greater density of connected devices. This should support new use cases, possibly including fixed wireless access, smart homes, the “Internet of Things”, advanced driver-assistance and augmented reality. Importantly, national security concerns have catalyzed a global race to adoption. We see potential winners across the supply chain, from infrastructure suppliers to application developers.

The burgeoning market for legal cannabis in both the US and Canada has prompted a wave of companies to raise capital in order to take advantage of this emerging growth opportunity. In recent years, nearly half of U.S. states have legalized cannabis for medical or recreational use. Consumer packaged goods companies are rapidly getting up to speed on how cannabis derivatives might be used in food and beverage or health and wellness products, with some of the largest players acquiring stakes in publicly-traded Canadian companies to try and gain an edge in this regard. The pharmaceutical sector is also investigating therapeutic uses of cannabis-derived compounds, and a few have already been approved by the FDA. We believe this phenomenon is in its early stages, and we expect that the companies which successfully position themselves could see meaningful growth opportunities for years to come.

Pivots and Puts

Published on Jul. 15, 2019

Pivots and Puts

Market lore has it that former Federal Reserve Chairpersons Greenspan, Bernanke, and Yellen all provided the markets with what was effectively a put option. Hence the term, the “Greenspan Put”. If the economic signals started to get tough, the Fed would provide accommodative policy. This course of action would then presumably lead to a rally in bonds and stocks. Bonds would increase in price with the lower interest rates and the equity markets would rise on the prospect of continued economic growth. Former chair Yellen even suggested in a recent speech that the Fed should buy stocks and corporate bonds during recessions to help support the economy.

We believe that this policy has been easy for the Fed to carry out because of the lack of inflation. There’s vigilance for inflation, it is feared, but it hasn’t shown up. The Fed has not yet been caught in the dreaded place where they are behind in a fight against inflation. Since monetary policy acts with a lag, a Fed caught late in snuffing inflation has historically been a disaster.

Inflation has been kept at bay by the confluence of technology, global competition, and demographics, in our opinion. Technology has reduced costs, spurred competition, made pricing more competitive, and generally empowered consumers rather than producers. All this happens on a global scale. Demographics have been impactful too. As the developed world has grown older, there is less demand for goods and more demand for fixed income assets. Apparently, any reasonable instrument with yield is in demand. Pricing power in goods and services has seemingly been constrained by these forces.

Federal Reserve Chair Powell in Congressional testimony this week indicated that the door is open for the Fed to lower rates later this month. Powell served on the Fed uneventfully for six years before he was named Chair in early 2018. Perhaps only after he became Chair did he fully understand the import of his every utterance. Charitably, his October 2018 off-the-cuff comments about rates being low and “far” from normal may have added to the equity and credit spread woes of Q4 2018. By January 2019, Powell was inclined to read prepared comments and he gave us the term “patient”. Specifically, the Fed would be patient before raising rates. For Powell, being patient was a pivot and – in the end – it is a put too. This is the same accommodative stance that we have had from his predecessors. With inflation MIA, raising rates is not an imperative.

In our opinion, equities have responded positively and bond yields have returned to lower levels. The bond market now seems to have priced in several reductions in the Fed funds rate; the implied consensus of the CME FedWatch Tool is that by year-end, there will be two reductions of 25 basis points each. But bonds are also indicating an all clear signal on inflation. Because there are several narratives at play here, the story gets interesting.

Loud noises abound predicting an imminent recession. These voices could be rewarded with an expected Q2 manufacturing output data report likely to show a second straight quarter of declines, among a backdrop of weaker conditions overseas. The Fed is anxious about trade tensions and the waning strength of the global economy. But will there be a recession? US retail sales and housing activity are more robust, employment continues to be strong, and corporate profitability is not plummeting. In Powell’s mind though, even with the strong June jobs report, the economic outlook is not improving. Perhaps given the heightened trade-related uncertainties from the on again/off again status of increased tariffs on Chinese goods, a so-called ‘insurance’ cut is in order.

Equity Commentary | May 2019

Published on Jun. 11, 2019

Equity Commentary | May 2019

Market Overview

Trade issues were once again a focal point for capital markets during May. While investors came into the month optimistic that a deal with China was nearing completion, things appear to have taken a significant turn for the worse in recent weeks. The Trump administration hiked the tariff rate on certain Chinese imported goods, from 10% to 25%, and also placed export controls on Huawei, a leading technology company which many view as a Chinese national champion. Huawei was placed on a Commerce Department list of companies which are engaged in activities deemed to be harmful to American interests, the consequences of which could result in a ban on the sale of US technologies to the firm. Should this ban be fully implemented we expect that it would be extremely detrimental to Huawei’s business activities.

President Trump also recently announced his intention to place tariffs on Mexican imports in an attempt to reduce illegal immigration across the southern border. The plan called for an initial 5% tariff on all Mexican imported goods which would have increase by an incremental 5 percentage points every month until the administration’s concerns were addressed. As of this writing however, it appears that last minute negotiations have been successful, and the tariffs are not expected to go into effect. Still, just the threat of their implementation took investors by surprise, and in our view added to already heightened uncertainty with regards to how these and other trade related negotiations will play out, as well as their impact upon global supply chains and economic activity.

We believe that the elevated trade related tensions in recent weeks have had a material impact on capital markets and business conditions. While the direct impact of a potential 5% tariff on Mexican imports would likely have been immaterial to the US economy, other potential consequences such as sowing distrust among our trade partners and a lack of clarity for US corporations could be quite problematic. Most observers believed that the US, Mexico and Canada reached a trade deal six months ago, and we cannot help but think that other countries which have recently entered into trade agreements or are in the process of negotiating them might now be skeptical that the terms of those agreements will be honored. Some businesses have reacted to the tariffs on Chinese imports by adjusting their supply chains, in some cases moving production out of China and into Mexico. These companies may have been adversely impacted should the Mexican tariffs had gone into effect, but more broadly this level of uncertainty makes planning very difficult for businesses, and our concern is that some may respond by slowing or freezing hiring and investment. We believe heightened trade tensions played a large role in the S&P 500’s 6.5% decline during May and are also likely contributing to the inverted yield curve.

US economic data appears to be uneven of late. Surveys of the manufacturing and service sectors, while still indicative of growth, have come in below analysts’ expectations. The latest readings on capital goods orders and retail sales have also been soft. As a result, most projections for Q2 GDP are now calling for less than 2% annualized growth. Core growth during the 1st quarter, adjusting for inventories and trade, was sluggish but there was a consensus view that certain one-time items such as the government shutdown, delayed tax refunds, and unfavorable weather conditions were largely responsible, and that growth would accelerate during the 2nd quarter and beyond. This most recent spate of disappointing data has called this view into question. Moreover, the inverted yield curve may be flagging problems ahead. At the moment we do not believe that the inversion has persisted long enough to be considered a reliable indicator of a near-term contraction. However, should it persist for another few months, it would cross the threshold at which past yield curve inversions of similar duration have been very accurate in predicting impending recessions.

There are reasons for optimism. Consumer confidence has held up well. Productivity appears to be strong and inflation remains at low levels. If trade circumstances were to improve, it is possible that an accompanying increase in corporate confidence could pave the way for a solid 2nd half of economic activity. We also believe that the Federal Reserve will not hesitate to use its tools to ease monetary policy if the economic data continues to weaken. The market seems as if it is beginning to anticipate just such a scenario. The biggest risk to markets in our view is that trade related tensions do not subside, and corporate and investor confidence falls during a period in which the economy may already be slowing.

Six Market Thoughts on Trade, Tariffs, China, and Choppy Markets

Published on Jun. 5, 2019

Six Market Thoughts on Trade, Tariffs, China, and Choppy Markets

– Politics don’t seem to matter much to markets until they matter

– The S&P 500 is down about 7% from its late-April high

– The yield curve inversion seems to be giving investors jitters of recession

As usual, there is a lot to digest and this is only a partial list, but it incorporates the essentials. The larger anxieties are being generated in the geopolitical realm, and yet cooler heads recognize that all sides in trade disputes need deals. It is at least true that everybody could be better off.

But this doesn’t guarantee that the necessary accommodations and arrangements will happen. At a minimum, we believe that continued tensions could lead to lower economic growth, perhaps a recession. The market’s view on this, it seems, is that the Federal Reserve stands ready to ease.

As of this writing, the yield on the active US Treasury notes, out to the ten-year maturity, all trade lower than the Federal funds rate. This is understood to reflect the bond market having already “priced in” the next interest rate moves by the Fed’s rate-setting body to be a reduction in the Fed funds rate. Explicitly, the CME’s Fed Watch Tool records over a 50% chance of a lower Fed funds rate being priced in at the FOMC’s July 31st meeting.1

Remember that the Fed has two important objective functions: full employment and stable price levels, and it attempts to implement policy targeting these two objectives with essentially one tool, adjusting the level of short-term interest rates. The geopolitical threat, through trade tensions, is a threat to employment. Specifically, the forward concern is whether a rise in the cost of goods (the result of tariffs and restraint of trade) would cause reduced consumer spending, job losses, and a drop-off in economic growth. This is the case for the Fed to take proactive steps and lower rates.

There is, however, an additional reason for the Fed to lower rates. With regard to the Fed’s 2% inflation target, inflation has stubbornly refused to cooperate and has remained consistently below that target. Recent comments by Fed Chair Powell, Vice Chair Clarida, Former Fed Chair Yellen, Boston Fed President Rosengren, Chicago Fed President Evans, and New York Fed President Williams have all addressed the Fed’s efforts – and lack of success – in pushing inflation towards that 2% target. The number is important because the Fed sees it as consistent with healthy economic growth. If markets, households, and businesses expect inflation to remain below 2%, the Fed’s concern is that lower growth expectations become ingrained.

Fed funds currently are targeted at 2.25-2.50% and inflation readings are closer to 1.5%. Given this, the expectation of a rate cut seems justified by the shape of the yield curve and the CME’s Fed Watch Tool. What’s missing from this analysis is that the GDP trackers, which are compilers of economic data providing running totals in real-time, are not indicating that the economy is moving into recession at all for the second quarter. It might be useful therefore to view the yield curve’s protest as one of too low inflation, rather that of negative economic growth.



Published on May 23, 2019


If one were prone to worry, there are lots of things to be uneasy about. Ongoing tensions in the international political situation might be a good place to start, with trade disputes front and center. It appears that the markets have spent the last few weeks digesting the likelihood of continued trade disruptions. Reasonable people likely have their own list of other concerns. One we seem to keep hearing about is whether a recession is imminent.

Business cycles wax and wane; that’s been the general story. Since the ‘08 financial crisis, we have experienced a lengthy, but never frothy, recovery. Most market wags anticipate that, at some point, the economy would be expected to turn lower, if only because that has been what history shows. Given that it has been about ten years since the last downturn, it’s almost logical to hear warnings of recession ahead. However, past Fed chair Janet Yellen once said that economic expansions don’t die of old age. It’s reasonable to ask, “What would be the trigger?” and “Can I know in time?”

Preceding the last several recessions, there were some recurring mileposts which may serve as warning flags for the arrival of the next recession. These included a pickup in unemployment claims, an inverted yield curve, average hourly earnings growing by an annual rate of roughly about 4%, a surge in commodity prices, and a Federal reserve that had been hiking rates for between 3-7 years. Let’s examine these data sets and see if they’re giving us any signals we should be concerned about.

Maybe first on the list would be employment. Recent job gains appear to be substantial and the unemployment rate has moved lower. The April 2019 unemployment rate was 3.6%. This is the lowest rate of unemployment in about 50 years.

Graph of Civilian Unemployment Rate

Weekly unemployment claims also show a healthy economy. When an economy is weakening, evidence often shows up in unemployment claims. But claims remain near historic lows. Nothing to see here, folks.

Graph of 4 week moving average of initial claims

Next on our list is the Treasury yield curve. Here the reader can make his or her own “call”; the three-month Treasury bill and the ten-year Treasury note are in the same yield neighborhood. Inverted, no, but worth watching.

Graph of 10 year treasury constant maturity minus 3 month treasury constant maturity

The next milepost to watch is average hourly earnings. In the chart below, the annual growth in average hourly earnings has been increasing in recent years but remains below 3.5%. So again, it bears watching but nothing to be too concerned with here.

Graph of Average Hourly Earnings

Next on our list is a surge in commodity prices. One of the best barometers to check here is the Commodity Research Bureau (CRB) raw industrials spot price index. We are looking for a surge, or meaningful move upward. While it could be said that there was a surge in 2015 following the decline of 2014-15, it seems pretty clear that nothing in the 2018-19 timeframe in the chart below could be called a surge.

Graph of Commodity research Bureau raw industrials spot price index

Federal Reserve and rate hikes. We can see in the chart below that the Fed embarked upon its current rate hiking cycle in late 2015 and after waiting a year, conducted a number of subsequent hikes in the Fed Funds Rate. For now the Fed appears to be on pause, reversing course in January after making comments late last year implying there were more rate hikes to come. Nonetheless, this data set tells us that the Fed has indeed been hiking for several years now. So with respect to this particular milestone, we can check the box.

Graph of Effective Federal Funds Rate

So to recap, of the five milestones we reviewed which are likely to help provide a heads’ up of the next recession, whenever it may arrive, we have one check mark (Fed rate hikes), two to keep an eye on (inverted yield curve and average hourly earnings), and two which are showing no signs for concern (weekly unemployment claims and commodity prices). What this tells us is that if our current cycle is typical, we shouldn’t be concerned about an imminent recession at the present time.

The trade war with China is still a developing story, and it’s possible that future developments which we cannot predict may negatively impact our economy and help bring on a recession. But it’s also possible, if not probable, that well before such a scenario came to fruition, a deal will be reached between the two sides that could reduce or eliminate the negative impact to our economy. Such a deal would go a long way to improving confidence among businesses globally which are trying to navigate the choppy waters created by the wake of the trade war between the U.S. and China.

Given that this economic cycle is different in some ways from the last cycle, even though it may rhyme, what brings on the next recession might well be something completely different than what brought on the end of the last cycle (implosion of massive housing bubble, Fed rate hikes, financial crisis).

At Roosevelt, part of our investment process includes monitoring the economic data and discussing its implications on the portfolio and on the cycle. We’ll continue to be vigilant on this front since our cycle is indeed long in the tooth, but for now we do not believe a recession is likely in the next 12 months.

Opinion on the U.S. and China Trade War

Published on May 17, 2019

Opinion on the U.S. and China Trade War

The following is the opinion of Richard Kilbride, Managing Director and Fixed Income Specialist at Roosevelt Investments.

When we all said that a US-China trade deal was priced into the market, we were right. Now that that tension is front and center, it has stirred significant angst. Even if this is just a negotiation process, it isn’t transitory. The process to a fairer, but still free, trade system is a long way from a firm foundation.

The path of least resistance is to lower bond yields. Already underperforming global growth and absent inflation drive that too; inflation has been below 2% for a decade. That trade disputes will raise the cost of goods is not the immediate concern. Older folks remember a bi-polar world, two spheres of influence, one headed by the USA and the other by the Soviet Union. Separate, rarely cooperating on anything, and missiles at the ready, that world saw other countries pick sides as the two superpowers vied for influence. If you are an economist, and not a political scientist, the West won because they had better access to financing. Yes, the West also had better laws, standards of living, and better human rights, among other advantages. But it also took almost 50 years for the West’s advantages to play out and maybe it was nip and tuck there for a while.

The US and China have been seeking to play nice together in the global sandbox for some time. China’s joining the World Trade Organization (WTO) in 2001 was perhaps the biggest step. But quite quickly, by as soon as 2007, China’s wealth had grown such that many market prognosticators viewed the Chinese funding of both the US trade and budget deficits, effectively in exchange for their export goods, as unsustainable. Together it all balanced of course, as significant Chinese savings were deployed to buy and hold US securities. We bought their goods, and lived beyond our means, in exchange for them holding our paper. For the Chinese, producing export goods created employment in the great eastern cities as their population moved away from agricultural pursuits.

Enter the financial crisis in the West, which has been blamed on derivatives, or that housing prices had been too high, or on flawed mortgage lending practices, or on liar loans and people borrowing too much, or on inept regulation, or on government policies that over-supported housing and homeownership, or that rates had been held too low leading up to the crisis and investors had been forced to stretch for yield, or that Wall Street firms had too much leverage, or the accounting rules that forced mark-to-market practices creating effective margin calls, or maybe even that Lehman never built enough capital after Bear folded. We’re still working out this narrative. But China’s role and influence got lost in there, and all along containership after containership landed goods here. After the WTO negotiation, China was to open its market. It became the world’s biggest exporter (13% of the total), home of 12 of the world’s 100 most valuable listed companies, and they created enormous prosperity. And if it was simply a matter of Chinese buying US bonds and the US buying Chinese goods, all would be well.

The tensions go beyond that. There are strong views that China didn’t follow the plan. Instead of being a responsible participant in the international order, Beijing has used its new economic might to launch a drive against Western power and primacy that appears as if it could define world politics for decades. In the West, this has stirred up forces hostile to foreign competition and suspicious of free trade. At the same time, markets have been clearly signaling that many of the S&P 500 constituents might be a lot more closely interconnected with China than previously believed. Further, a wealth of academic and policy research over the past generation has shown that globalization tends to raise, not lower, productivity and average incomes. Incomes tend to increase the more that companies and countries are connected to the global economy via international trade, investment, and immigration. This clearly reflects that the forces of globalization should be a very positive thing. Globally, billions of people have been lifted out of poverty in the last generation. Life spans have risen, hunger is down, illiteracy is down, and child mortality is down. Critically then the economic policies that boost growth in productivity and thus in average incomes look to be global policies. This is as old as Ricardo, and still true.

In some countries, some dimensions of globalization—for example, China’s growth in exports related to its membership in the WTO—have put downward pressure on the wages of some workers. Many Americans lost jobs, and though that isn’t the problem as much today, memories and tensions linger, and victims need a scapegoat. Of course, worker productivity is shaped by many forces other than globalization, such as education and technology. But policies related to trade can often be shifted much more quickly and less expensively compared with longer-run, productivity-shaping policies, such as schools or worker training. So, we arrive at the globalization paradox. We know the clear merits to globalization and yet global policy is drifting away from support. Even though all the dynamism that globalization fosters raises average incomes, anxiety about who plays fair is pushing many countries away from rather than toward the policies of more globalization. By turning countries inward, disaffected labor-market performance – part of what drives the anxiety – may even be accelerated.

The western relationship with China seems to be the bet that failed. The expectation was that putting China in the WTO, and other such institutions, would bind China into the rules-based systems set up after WWII. Instead the rules for global trade have been upended as China wishes to play by its own rules. Further, it was hoped that economic integration would encourage China to evolve towards democracy; as they grew wealthier, its people would yearn for democratic freedoms, rights, and the rule of law. Instead, any hopes of movement towards constitutional law has been replaced by politics and economics being steered towards repression, state control, and confrontation. The West was wrong when it expected China to tilt towards a more market-based economy.

This leaves the West and China as ideological and economic rivals. This strain is about the direction, speed, and end game for the relationship, and for our focus, the markets. At a minimum, Beijing is encouraging the spread of authoritarianism. Chinese businesses are arms of state power, including industrial espionage and state-sponsored raids on intellectual property. The Chinese Communist Party’s powerful departments that control personnel and policy don’t exactly list their phone numbers or display signs outside their offices. All the operations are silent. What can resolve this? We know globalization works, but US policy cannot be offering people more globalization only. When people say they are worried about the ability to compete and have their intellectual property protected in the global economy, they tend not to like being told that more globalization and competition is the answer. We also need an array of related policies to allay the unfairness that firms and people experience. Are there still rules? Can we negotiate rules when counterparties renege on previously agreed-to items? How much should we look the other way on IP, forced technology transfer, and subsidies to secure a deal? How do we make progress on these critical items while still allowing the Chinese side to save face, a very important and overarching factor in their culture. These are difficult matters to resolve.

This may be a muddle, a long muddle. The US-China negotiations have been thwarted by miscalculations and unfulfilled expectations. We are interconnected, but we are in competition too. While the longer the impasse, the greater the economic fallout for all, we also need to know if everybody is playing by the same rules, rules which will benefit the greatest number of people. At its heart, the squabbles are over things like 5G, artificial intelligence, and other data-driven services. These are things that we have not yet even figured out much less do we understand their long-run impacts. And as these bridge the cyber line between military and commerce, economic considerations overlap with national security issues. It’s hard to expect anything but a long impasse; perhaps some cease fire pacts along the way, but a very difficult risk for global economies, central banks, and markets. We can hope this all eases, but there are no illusions here, and hope is never a good trading strategy.

The opinion of Richard Kilbride does not necessarily reflect the views of Roosevelt Investments.

Latest Market Commentary

Published on May 13, 2019

Latest Market Commentary

Market Overview

Economic conditions in China appear to be improving. In March, the manufacturing PMI returned to a level indicative of expansion for the first time in 4 months, and factory output reached its strongest level since late last year. While April’s manufacturing PMI was modestly below analyst’s expectations, it too remained above the expansion threshold. Industrial production and retail sales showed healthy gains during March and exceeded consensus projections. We think that these improvements are significant as China’s economic growth has decelerated every year since 2010. If growth in the world’s second largest economy were to stabilize or reaccelerate, we believe it could positively impact its trading partners and capital markets across the globe.

We attribute some of China’s recent strength to a significant tax cut implemented earlier this year, as well as liquidity injections from the country’s central bank. A successful trade deal with the US could give an additional boost to China’s growth profile. In this regard, we note that the two countries have reportedly agreed on enforcement mechanisms to police a potential trade pact. We believe this is meaningful as this issue had previously been a point of contention. We continue to expect the US and China to reach an agreement on trade, as it is in the best interest of both sides to do so, though timing is uncertain particularly in light of the events of the last few days.

In contrast, the European economy remains weak. The manufacturing PMIs for both March and April came in below 50, indicating that the sector is contracting. In its commentary, survey data provider Markit noted that “the economy remains in its worst growth spell since 2014. Manufacturing reported a further contraction and service sector growth cooled.” Moreover, GDP projections for Germany and Italy have recently been revised down. The Italian government now anticipates growth of just 0.1% this year. It appears that the ECB is closely watching these conditions, and is attempting to counteract them by delaying interest rate hikes and rolling out a 3rd round of its targeted long-term refinancing operations (TLTRO), which are loans to financial institutions at attractive rates that are designed to stimulate lending to the real economy. We are encouraged by the ECB’s efforts though the challenged European economy remains a risk to capital markets in our view.


We believe that the US economy appears healthy as evidenced by the recently released Q1 GDP report, which came in at a stronger than expected 3.2% annualized growth rate. There are reasons to believe that solid domestic growth may be sustainable, given the healthy state of the labor market and benign financial conditions. Perhaps most significantly, this growth is being accompanied by a general absence of inflationary pressures, which has enabled the Fed to remain dovish. In our opinion solid growth and an accommodative Federal Reserve typically bode quite well for stocks. Moreover, first quarter earnings are exceeding expectations. Investors were quite cautious heading into earnings season, with consensus analyst projections calling for a low single digit year-over-year decline in S&P 500 earnings. As of this writing however, with approximately 80% of S&P 500 companies having reported first quarter results, aggregate earnings are up 3.2%.

We believe there are reasons for caution. Stocks have been on a strong run, having moved up approximately 25% since last December’s low, but the recent breakdown in the US-China trade talks may create choppy market conditions in the near term. International economies remain challenged, though we suspect the worst may be behind them. Finally, as the 2020 US presidential election draws closer, we expect to hear a lot of potentially market-moving rhetoric on a number of important issues including health care, taxes and climate change. Market volatility could pick up as the candidates debate policy and make stump speeches on these topics. Despite these risks, we view conditions as generally favorable for investors in equities.

Speed Bump

Published on May 13, 2019

Speed Bump

After enjoying the stock market’s advance in each consecutive month so far in 2019, over the past week investors hit a speed bump, as U.S.-China trade issues have returned to weigh on sentiment. Headlines and signals emanating from both sides in recent weeks suggested an agreement was near. But according to Reuters, as discussions reached the final stages, the Chinese side stripped out legal language it had previously committed to throughout the draft document.

It appears that these commitments were in areas deemed critical by the U.S., including intellectual property protection, forced technology transfer, and verification of compliance. In response, on Friday the U.S. imposed additional tariffs on Chinese imports to begin at roughly month end, leaving a modest hope that in the coming weeks the two sides might reach an agreement that would avert them. The Chinese retaliated with incremental tariffs on U.S. imports, but their ability to respond in this fashion is somewhat limited, since they do not import as much from the U.S. as we import from China.

We believe it is likely that China has more to lose in this battle. The Chinese economy, while growing at about 6%, has been slowing for many years, and Beijing has engaged in a variety of measures to prop up growth, including lowering interest rates and setting ambitious targets for bank lending. The Chinese banking system appears to be highly leveraged, and may be susceptible to a slowdown in growth. Moreover, the Chinese economy is dependent on exports for a majority of its growth. In our opinion the U.S. economy grew strongly in the first quarter despite a government shutdown and severe weather that may have negatively impacted economic activity, and in general is not export-dependent for growth. The U.S. is not immune to higher tariffs imposed in this trade war with China, as many of the tariffs will be borne by consumers and/or companies. But tariffs are not likely to put a big dent in the economy’s overall growth, though some companies may be negatively impacted more than others.

Many companies that sell goods in the U.S. are re-working their supply chains so that they are not dependent upon China. Once such changes have been made, perhaps by shifting production to Southeast Asia or Mexico, they are unlikely to be reversed. In this regard, the longer the U.S.-China trade dispute persists, the more permanent the rerouting of supply chains will be, which has negative implications for China.

The U.S.-China trade dispute began over a year ago with targeted U.S. actions in sectors including solar panels, steel and aluminum, followed by broader tariffs. Against this backdrop, we have over the past year endeavored to bolster the resilience of our equity portfolios against the risk of escalation. In general we reduced our exposure to companies that we believe are vulnerable, while adding investments in areas that we thought would outperform a market pullback sparked by the trade dispute.

Nevertheless, we have retained some holdings which experience elevated volatility when trade-related issues hit the market. In general these are well-managed quality companies that we believe have a bright future. We expect they will provide attractive returns in the long run. In most cases, when the market is trending higher, as it has so far this year, these stocks benefit from an additional tailwind because of their exposure to cyclical economic growth. And should the U.S. and China again move closer to a trade agreement, these companies would likely return to market leadership. Our clients should know that we have taken limited action in response to the headlines of the last week, largely because we have factored the risk of trade escalation into our thinking over the preceding twelve months.

Current Income Portfolio – First Quarter Commentary

Published on Apr. 26, 2019

Current Income Portfolio – First Quarter Commentary

Market Overview

The beginning of 2019 saw a reversal of the credit market themes that dominated the closing months of 2018. With the exceptions of U. S. Government and very high-grade corporate issues, most of the domestic credit markets suffered pricing declines in response to what we believe was widespread anxiety over continuing monetary policy tightening, possible credit quality deterioration, investment grade yield spread widening and geopolitical uncertainties. These factors appear to have combined and led to a classic ‘flight-to-quality’ environment of uneasiness, particularly in December.

In January, however, and continuing on over the rest of the first quarter, these concerns seem to have abated and both bond and equity market conditions improved, helped in part we believe by a newfound dovishness on the part of the Fed, as well as some evidence of macroeconomic improvement and hints that perhaps a resolution to the China trade was might be possible.

While the ten-year U.S. Treasury was relatively stable, trading around a twenty basis point range, other investment grade credit markets were more volatile. Specifically, the spread widening observed in the corporate bond market, which had occupied much of the business press late last year, fell back comfortably into historically tight ranges. The yield spread of investment grade corporate issues rated single A fell about 21%, from 1.20% at the close of 2019 to about 0.95% at quarter end. Likewise the yield spread of investment grade corporate issues rated BBB fell about 19%, from around 1.90% at the close of last year to about 1.58% at quarter end. Spreads for both types of issuers are now approximately in line with where their historic averages since 2014.

Similarly, the preferred securities market which in the fourth quarter suffered through one of the most disappointing performance quarters in terms of total rate of return in our recent memory, reversed and rallied back sharply in the first quarter. The ICE BofAML Fixed Rate Preferred Index posted an 8.71% total return for the first quarter of 2019, following the previous quarter’s 4.56% negative total return. And the ICE BofAML Capital Securities Index, which specifically tracks the $1000 par preferred security issues, posted a 6.43% total return for the first calendar quarter, following the previous quarter’s 2.55% negative total return. In both cases, the combined two-quarter total returns averaged about 4.0%, historically slightly higher than recent experience would suggest.

The intermediate-term investment grade corporate bond market, benefitting from the return of yield spreads to historical norms, also posted relatively strong quarterly total returns. The ICE BofAML 1-10 Year US Corporate Index had a first quarter total return of about 3.80%, following a Q4 2018 total return of about 0.61%. This performance was significantly stronger than the ICE BofAML 1-10 YEAR US Treasury Index which posted a 1.57% first quarter return, following the previous quarter’s 2.20% total return. Over the last two quarters, we believe that the intermediate corporate market has benefitted significantly from slightly lower U. S. nominal interest rates and tighter investment grade yield spreads.

To cap things off, the Federal Reserve Board policymakers announced delays in future monetary policy adjustments. In combination with reversals of credit spreads and a beneficial re-pricing of the risks of holding preferred securities, the slightly negative returns for Current Income Portfolio accounts in 2018 were more than clawed back with a nearly 4.4% total return in the first quarter. This compares favorably with the 1–10 year investment grade corporate market which posted a return of 3.8% as well as the broad Intermediate Government/Credit benchmark total rate of return of 2.32% over the same period.


We believe the advantages of the building our Current Income Portfolio accounts around a balance of intermediate-term investment grade bonds and preferred securities is demonstrated by the style’s performance over the ups and downs of the rather volatile past six months. We believe that underlying these accounts is a steady income characteristic that has remained undisturbed through periods of market volatility, both higher and lower.

New accounts are presently funded at about 4.52% current yield, which is above the level of the product’s stated benchmark as well as the intermediate-term corporate market. Moreover, our incorporation of investment grade preferred securities tends to elevate the style’s overall current income and yield characteristics, but does so in a limited and identifiable manner. To this point, while the portfolio’s yield matrices are higher than alternative investment grade fixed income offerings, especially mass market alternatives such as full market mutual funds and ETFs, interest rate risk assumed by the Current Income Portfolio is currently lower (as measured by modified duration). New accounts presently feature a corporate bond duration of about 4.08 compared to the intermediate benchmark’s approximate 4.16, and this duration may be allowed to decline over the remainder of 2019 as portfolio holdings get closer to maturity and thus shorten in term.

By remaining loyal to our objectives of seeking to provide the highest possible returns while assuming the least possible risks, we have sought to take advantage of the market’s recent pricing volatility. Discounted prices in the preferred securities markets offer the opportunity to slightly increase our allocation in this sector. While we would have preferred higher nominal rates, most long-standing accounts are able to benefit from the Current Income Portfolio’s design which provides for regular reinvestment of bond holdings in the corporate sleeve as they mature or are called. The use of perpetual, fixed rate preferred securities, which remain potentially price sensitive to general interest rate rises, does not, at this point, dramatically increase the portfolio’s overall interest sensitivity. Higher coupon fixed rate issues and positions in fixed-to-floating rate preferred issues tend to reduce the overall portfolio duration. While we believe that the option for issuers to call their preferred securities at par after a designated date adds an element of risk to these holdings, we believe it is a risk that investors are compensated for through the higher yields on these securities. This structural characteristic may at times also provide an anchor to keep prices trending toward par values as cycles progress, therefore perhaps helping to both dampen the volatility of and enhance the attractiveness of investing in, these issues.

To us, guessing the future direction of interest rates remains a fool’s errand. Our expectations of when monetary policy may next effect nominal interest rates, either by resuming tightening credit conditions (raising short-term interest rates), or by beginning to ease credit market conditions (lowering nominal interest rates) are just an educated guess—and we and the markets at-large have been wrong as often as not. We believe therefore that the most productive approach to safely generating higher income is to identify and execute the sector allocations and positions that we believe currently will produce the highest levels of current income available while assuming the lowest levels of risks to achieve our underlying goals of principal preservation, without expressing a strong view on the future direction of rates.

First Quarter 2019 | Equity Commentary

Published on Apr. 15, 2019

First Quarter 2019 | Equity Commentary

Market Overview

Stocks enjoyed a strong start to the year, as the S&P 500 advanced about 13.7% during the 1st quarter. We believe that optimism regarding a potential US China trade deal and an increasingly dovish Federal Reserve likely helped to drive these gains. While economic activity appears to have weakened of late, there are reasons for us to believe that growth may reaccelerate during the remainder of the year.

We believe that an increasingly dovish Federal Reserve was one of the key factors impacting markets during the first quarter. As recently as last October, Fed Chairman Jerome Powell was anticipating a steady course of interest rate hikes for the foreseeable future. At the moment however, the central bank appears to be have put further interest rate hikes on hold, and we believe that market-implied odds suggest a realistic possibility that the Fed might even cut rates later this year. Expectations may have also shifted with regards to the balance sheet normalization process, where it now appears that the Federal Reserve will ultimately maintain a larger balance sheet than many economists previously anticipated. In addition, Chairman Powell has suggested that he would like to see inflation modestly above the Fed’s 2% target for a period of time. While that objective has yet to be achieved, the mere fact that the Fed would like to see it happen is another dovish development, in our view.

In our view trade negotiations between the US and China have been a focal point for investors for some time now. While the discussions are ongoing, we understand that the tone coming out of the Trump administration has been much more conciliatory in recent months. We believe that increasing optimism among investors that a deal will be reached has helped to boost stocks. However, failure to reach an agreement could roil global capital markets. In our view, the most likely outcome is that a deal will be reached, though it is premature to speculate on its impact without knowing the granular details.

Global economic activity appears to have slowed during the first quarter. We believe that investors were particularly disconcerted by the Eurozone manufacturing PMI for March which came in at 47.5, a level which implies that the sector may be contracting. Germany’s number was weak at just 44.1, well below consensus expectations. While the US manufacturing PMI of 52.5 appears to be healthier, it too missed expectations. Bond yields sank in the wake of these releases, temporarily inverting the yield curve and exacerbating investor growth concerns.

While we view the temporary yield curve inversion as a yellow flag, we are not overly concerned that it was signaling an impending US recession. We have noticed that in the past, the yield curve has typically inverted during periods in which the Federal Reserve had been raising rates, suggesting a monetary policy mistake. That is not the case today as the Fed has not increased interest rates since December, and market indicators suggest that the Fed’s next move appears to us more likely to be a rate cut rather than an increase. Secondly, prior yield curve inversions which have foreshadowed recessions have persisted for a much longer duration, and were of a greater magnitude than March’s inversion which only lasted for a couple of days, and inverted by just a few basis points. Technical factors also may have played a role, as a recent large issuance of short-term Treasuries probably resulted in higher yields at the short end of the curve. Finally, we note that European bond yields are currently quite low and even negative in some cases and are likely pressuring US yields. Therefore, elevated US bond prices may be as much a function of relative value compared with European bonds as they are indicative of flagging domestic growth. For all of these reasons, while we are keeping an eye on what remains a flattish yield curve, we do not believe that the recent inversion is a sign that the US economy will be falling into recession anytime soon.


We think that the risk-reward dynamic for equities is reasonably balanced at the current time. While we expect that economic growth will likely pick up in the coming quarters, we believe the recent run-up in stock prices largely encompasses this view. Our optimism on future economic activity is based on several factors. We believe that the first quarter was pressured by certain non-recurring issues such as extreme weather and the government shutdown, the impact of which are unlikely to persist. We expect that benign financial conditions should also help to support the economy, as stock prices have risen, interest rates remain quite low, and credit spreads have tightened. Lower interest rates have also favorably impacted mortgage rates, which currently sit at just over 4% for a 30-year fixed rate mortgage, a considerable drop from just a few months ago. We think that this dynamic has boosted the housing market, as new home sales, starts, and affordability are all trending favorably. Lastly, measures of consumer confidence are close to 12-month highs, unemployment claims are at very low levels, and bank loans have been picking up. In our view, these indicators suggest that growth is likely to reaccelerate moving forward.

International growth however, remains a key concern. One need look no further than the European government bond market, where anemic yields are reflecting investor anxiety regarding the region’s growth prospects. As noted above, purchasing manager indices reflect a contracting European manufacturing sector, and the ECB recently downgraded its projection for 2019 Eurozone GDP growth to just 1.1% from an earlier estimate of 1.7%. Brexit remains an unresolved issue which we think has been at least partly responsible for the Eurozone’s weakening profile, as management teams hold off on making important investment decisions given the heightened levels of uncertainty. The deceleration of China’s economy may be an even larger factor impacting European growth. We believe that a US-China trade agreement could help reinvigorate the world’s 2nd largest economy, though structural issues internal to China have likely played a larger role in its growth challenges.

As we put all of these pieces together to assess the current investment environment, we want to be more or less fully invested, but with an emphasis on companies that are not overly dependent on a strong economy and that we believe can perform well in a low interest rate environment. We believe that this should help to buffer the portfolio against potential market downside should the domestic economy fail to strengthen, or if international growth were to decelerate further.

Don’t Fear the Curve

Published on Apr. 10, 2019

Don’t Fear the Curve

Within the community of market analysts, it is well understood that an economic slowdown (and even a recession) can be signaled by an inverted yield curve, with about a year’s lead time, because the inversion in the curve can signal that interest rates in the future may be expected to be lower than rates today. “Inversion” refers to the fact that the yield on short-term notes exceeds that on longer notes.

At this writing, the yield on three-month Treasury Bills exceeds the yield on three-year Treasuries, which have the lowest yield on the U. S. Treasury curve. Do we freak out?

Probably not! We believe that the future isn’t always like the past and, after a decade of near-zero rate monetary policy, perhaps the recession-signaling value of the inverted yield curve needs further examination.

Our working hypothesis is that lower long-term rates have less to do with an economic slowdown and more to do with low inflation expectations and limited economic volatility. Yes, in the past four years the Fed implemented nine rate increases in the Federal funds target rate of 25 basis points each. It did this initially to lift the rate out of the post-’08 extreme accommodation approach, because monetary policy generally operates with a lag, to dampen an economy as employment started to soar. The expectation was that wage pressures would not be far behind employment growth. The Fed may have hoped to be able to ease inflation expectations in an attempt to control inflationary pressures. We think that the acceleration in employment is a big story. We believe that the labor market is solid, which should continue to provide for contributions to consumption, an important driver of economic activity.

The accelerating inflation story hasn’t played out, or hasn’t played out yet, as inflation has been lower than expected. We chalk this up to technology, demographics, and globalization because together they have held down costs and pricing power. We believe that for the Fed, the dilemma is that the economy is growing and unemployment has dropped, yet inflation hasn’t accelerated. It’s a good problem to have if you fear inflation, but the Fed may have expected more inflation at this point in time. Because of this it appears that on the surface, we have restrictive monetary policy and that is why we think calls are now being made by pundits for the Fed to lower rates.

We believe that the bond market is signaling a healthy economic environment. Credit markets had a strong first quarter, and to us the tightening of credit spreads is indicative of healthy balance sheets and firms meeting their financial goals. For us, this translates into what we believe may be a continued period of steady economic growth and returns for investment grade credit securities. If credit spreads were to widen, that would be a concern for us.

Equity Commentary | February 2019

Published on Mar. 19, 2019

Equity Commentary | February 2019

Market Overview

Stocks moved higher during February, with the S&P 500 returning 3.2% for the month. We believe that expectations for a favorable resolution to US/China trade disputes and dovish signs from the Federal Reserve helped to drive these gains. While we are encouraged by these dynamics, we are concerned that the market’s strength this year has left little margin for any deterioration in fundamentals or potential macroeconomic shocks.

We believe that optimism surrounding a potential trade agreement between the US and China has been one of the key factors benefitting stocks over the last several weeks. This would be beneficial for both countries’ economies, and could boost corporate earnings expectations, particularly for those companies whose guidance incorporates the tariffs remaining in place. While much of the good news may already be baked into current stock prices, we would expect that a mutually beneficial trade agreement between the world’s two largest economies would be warmly received by global capital markets.

Monetary policy has also aided stocks in our view. Investor focus has shifted to the balance sheet normalization process, which now appears likely to conclude more quickly and with the Fed holding more investment securities than investors were previously anticipating. In this regard, at his recent testimony to Congress, Fed Chairman Jerome Powell suggested that the central bank would maintain a level of reserves that is significantly greater than it had prior to the financial crisis. All else equal, more reserves and a larger balance sheet denote a more dovish monetary policy, which we believe has given a boost to stock prices. We anticipate that the Fed will continue to proceed with patience and caution. With regards to interest rates, it is possible that the Fed may be done hiking for the current cycle. While this remains to be seen, we do note that fixed income markets are signaling that the next Fed interest rate action is just as likely to be a cut as it is to be a hike.


While stocks have started the year in robust fashion, we are somewhat concerned that investors may be a bit too cavalier regarding uneven economic data in the US and abroad. GDP forecasts for Q1 are underwhelming, with projections that we monitor ranging from 0-1% annualized growth. Earnings estimates are also quite weak, as analysts are currently expecting a year-over-year profit decline for the first quarter. It appears as though markets are looking through these projections, anticipating that Q1 will be an anomaly with growth picking up thereafter. While we view this as plausible, it does suggest that stocks may be vulnerable, should this scenario prove to be overly optimistic. Moreover, the 2020 presidential election campaigning season is already underway, and we think this carries with it headline risk for stocks. Topics including the health care system and climate change are likely to garner a great deal of media attention. We think that various sectors of the market may be vulnerable as these issues come into greater focus.

That being said, certain key macro risks do appear to have lessened of late. As noted, negotiations between the US and China appear to be going well and the Fed has shifted to a considerably more dovish stance over the last few months. Moreover, a 2nd US government shutdown has been averted, and overseas the odds of a worst case Brexit scenario appear to have decreased considerably. We are also encouraged that signals out of the fixed income markets have improved, as the yield curve has steepened and credit spreads have contracted. These indications give credibility to the aforementioned notion that economic growth may improve following what is shaping up to be a weak first quarter. A strong labor market and healthy consumer may also benefit economic growth for the remainder of the year.

Ultimately, we are optimistic that fundamentals may improve as the year progresses, but we are concerned that at current levels this scenario is already largely priced into the market. Moreover, while we do expect that the US and China are likely to reach a trade agreement, a failure to do so could create quite a bit of turbulence for capital markets. We therefore think that the risk reward dynamic is slightly unfavorable for stocks at the moment. Should markets consolidate, or earnings prospects improve, we would likely upgrade our assessment.

Equity Commentary | January 2019

Published on Feb. 26, 2019

Equity Commentary | January 2019

Market Overview

Stocks rebounded from a difficult end to 2018 with a strong 8% advance in January 2019. Markets were buoyed by a dovish Federal Reserve and positive press reports regarding trade negotiations between the US and China. While we are encouraged by these developments, we think that after this latest run-up much of the good news may now be reflected in current stock prices, and caution that there may be less room for error should fundamentals weaken going forward.

We believe the Federal Reserve’s increasingly dovish stance was a key reason for the stock market gains last month. Key takeaways from the most recent Federal Open Market Committee meeting include a notable change in the press release regarding prospective policy actions from ‘further gradual increases’ to ‘future adjustments’. This is a significant change as it allows for the potential that the next policy move could actually be a rate cut. While we think this is unlikely, the mere suggestion of the possibility marks a meaningful change in tone out of the Fed. As recently as October 2018, Fed Chairman Powell appeared quite confident that the central bank would be steadily raising rates for the foreseeable future.

Moreover, at the press conference accompanying last month’s meeting, Powell noted that rates are presently within what he would consider to be a normal range, giving further credibility to the notion that the Fed is on hold and is unlikely to adjust interest rates higher in the near-term. He also indicated that balance sheet normalization may conclude more quickly and with the Fed ultimately holding more investment securities than previously expected. Moreover, Powell said the process could be adjusted based on economic and financial market conditions, another dovish development in our view.

According to media reports, trade negotiations between the US and China are going well. It appears that most investors now expect that at minimum the March deadline will be extended, if an agreement has not been reached by then. With decelerating global growth being a key risk factor for markets, it is likely that a trade agreement between the US and China could give a significant boost to investor spirits. As well, we think that improving sentiment on the issue in recent weeks was one of the factors helping to lift stocks during January. While the situation remains fluid, we are encouraged that negotiations appear to be moving in the right direction.

There was some mixed economic data out of the US in recent weeks, though we think the results were good enough to calm markets after some very weak December releases. The Institute for Supply Management’s (ISM) manufacturing survey rebounded to a solid 56.5 for January after missing expectations in December. Notably, the new orders sub-index, which weakened considerably in December, bounced back to a healthy 58.2 last month. The labor market continues to look strong with 312,000 jobs created during January, though wages were soft, growing just 0.1% on a month-over-month basis. The Citi Surprise Index, which depicts how economic data points in the aggregate are faring relative to consensus analyst expectations, has moved markedly higher of late. This supports our view that markets were largely pleased with January’s data releases.


In recent weeks, key market indicators including the CBOE volatility index, corporate bond spreads, oil prices, and the yield curve have all shown signs of stabilization or improvement. We are encouraged by these trends, particularly in the aftermath of a very turbulent December for capital markets. These developments, along with a better than feared start to fourth quarter earnings season and improving trade prospects between the US and China, support the bull case that stocks can continue to move higher following January’s strong gains.

Still, key risks remain, and softening global growth may continue to weigh on capital markets. Recent manufacturing surveys in China, Europe, and Japan have been hovering near 50, indicating very slow growth or in some cases contraction. The IMF recently lowered its global growth projections for this year and next, citing weakness in Europe and certain emerging markets, in addition to trade tensions and financial market volatility. As well, while recent domestic data has been better than expected, the current expansion is nearing the longest in US history and we think that as a result investors will be scrutinizing incoming data for any signs of an impending recession. This could lead to choppy markets going forward, particularly with the recent run up in stock prices leaving less room for any deterioration in fundamentals.

We think that a favorable resolution to the China trade war negotiations and improving macroeconomic fundamentals are potential sources of upside, while continued deterioration of macro conditions and a further ramping up of tariffs on China are downside risks. We are also somewhat concerned that damage has been done to consumer confidence and the confidence of business executives, which might take some time to repair. To its credit, however, the Fed has now adopted a view which is more supportive of markets. Therefore while we acknowledge that capital market conditions appear more stable today than even just a month ago, we think sufficient risks remain which leave us with a neutral, balanced view on stocks in the near term.

Release of the Doves

Published on Jan. 31, 2019

Release of the Doves

There were four 25 basis point increases in the Fed funds rate in 2018 and three in 2017. At the January 2019 meeting, the FOMC left the Fed funds rate unchanged at a target range of 2.25 – 2.50%. While the pause was expected, the language around it was significant. No longer are we being guided that there may be “some further gradual increases”. Instead the text of the FOMC statement is that the committee is “patient” as it decides what further adjustments might be appropriate.

This shift in sentiment comes after the markets had a tantrum in December and after a government shutdown (which may or may not resume). There are further uncertainties, particularly around our relationship with China, and the outlook definitely includes some gloominess. Perhaps there is some dust that needs to settle.

But if “patient” leaves any sense of ambiguity, Federal Reserve Board Chairman Jay Powell left little doubt at the press conference. This is not about being “patient” with regards to any further Fed funds increase. Rather “patient” is now a fork in the road, where the next change could be higher or lower. Welcome to neutral. The famous “dot plot”, Fed participant’s views of the path of rates, indicating that rates go higher is cast aside. In fairness it is not to be updated until March, at the next meeting. Look for substantial revisions. The hawks have flown off. We have the doves.

Rumblings of all this were apparent in the fourth quarter of 2018, with a noted sell off in leveraged loans as the markets sensed that economic conditions didn’t warrant higher rates. At times looking like a broad credit sell off, where everything that isn’t a government bond was for sale, in hindsight it now looks more like a liquidity event. Investors were dumping floating rate exposure, desirable holdings if rates were to move higher, but unattractive if not. They sold. What traded in the illiquid days of December was whatever could be sold. Credit spreads gapped wider. In January, gravity brought most of it back. Going forward, the economy is expected to grow, but less robustly. Growth outside the US is clearly weaker, especially in China and Europe. This creates drag to the US. Further, government policies remain a source of uncertainty. Brexit is the poster child of this, but governments globally are struggling with myriad but significant issues. This impacts confidence. Financial conditions are tighter, not only because of wider credit spreads, but simply because previous Fed engineered tightening impacts the economy with a lag. Inflation has become what looks like permanently benign. Finally, the outlook for corporate earnings is becoming more mixed. Single digit growth expectations are more common than double, as the positive effect of the tax cut legislation is anniversaried and companies face difficult comparisons. Our view remains that while growth will slow this year compared to last year’s robust numbers, the U.S. economy will still see a reasonable amount of growth.

During the fourth quarter preferred shares experienced one of their worst returns in a decade, but in January a broadly used preferred stock index has already recouped that drawdown as the market bounced back. This sort of price action shows the importance of not trying to time the market, good investment advice which spans both equities and fixed income securities. Roosevelt’s Current Income portfolio remains positioned with a mix of investment grade corporate bonds and preferred shares, the latter a mix of fixed rate and fixed-to-floating rate issues. As always, the investment team remains vigilant about the outlook and monitors the macroeconomic data on a daily basis.

Fourth Quarter 2018 | Equity Commentary

Published on Jan. 24, 2019

Fourth Quarter 2018 | Equity Commentary

Market Overview

Stocks fell sharply to close out the year, with the S&P 500 declining by about 9% during December and approximately 13.5% for the fourth quarter of 2018. Weak global economic data, continuing trade tensions, and a chaotic government backdrop created a difficult environment for capital markets. While we share these concerns, we note that the US consumer has thus far proved quite resilient, and equity valuations appear reasonable. Still, we are cautious on the market as we enter the New Year and maintain the risk-oriented approach that has helped us outperform for the year.

Investor sentiment appeared to shift markedly towards the end of 2018. We were surprised by the abrupt nature of this dynamic, as many of the key risk factors facing markets have been apparent for some time. A number of international economies have been slowing over the last few quarters, and tariffs on Chinese imported goods have been in effect for several months. We think that the concept of reflexivity – the notion that the capital market dynamics can influence real economic data – may have been a factor here. For example, a recent Duke University survey of corporate CFOs found that nearly half of respondents expect a recession to occur within the coming year. We think that the recent stock market volatility influenced these views and yielded a result that in our view appears elevated. Moreover, many investors were likely alarmed by the results of this survey, perhaps leading to a further decline in stock prices, and sustaining this self-reinforcing cycle which we think contributed to December’s weak results.

Following strong results in recent quarters, we think that some choppy economic data out of the US also likely played a role in the recent market volatility. Of particular concern are the Federal Reserve’s regional surveys for December, which as a whole missed expectations by a wide margin and fell sharply from November’s results. While we believe that reflexivity may have been a factor, we think the magnitude of the weakness is still somewhat alarming. For example, the Empire Manufacturing Index came in at 10.9 for December, down from 23.3 in November and well below the 20 that analysts had forecast. The Philadelphia, Richmond, and Dallas regional indices all followed a similar lackluster pattern. Moreover, the national ISM manufacturing survey also came in below expectations, with the index falling from 59.3 in November to 54.1 in December. Of particular concern, in our view, is the new orders sub-index, which declined sharply from 62.1 in November to 51.1 in the most recent survey. An ISM index number below 50 is said to indicate that the manufacturing sector is in contraction.

In contrast to these results, the consumer has been a key bright spot for the US economy. The labor market has held up well and wages are moving higher; perhaps as a result, consumption has been quite strong. Retail sales for November 2018 grew by about 0.9% from the prior month, easily exceeding consensus expectations for a 0.4% advance. As well, October’s retail sales gains were revised higher, to 0.7%. For the holiday period (Nov. 1 –Dec. 24), sales were up by approximately 5.1%, the best showing in six years. Furthermore, with falling gas prices, lower mortgage rates, and potentially larger refund checks from the tax reform, we are optimistic that healthy consumer spending may be sustainable.

There are signs that trade-related tensions between the US and China may be easing. While the situation has proved to be quite volatile, the agreement made at the G20 to refrain from additional tariffs until early March 2019 was a positive step, in our view, and negotiations are continuing in the meantime. China has also taken certain actions which we think will be viewed favorably by the Trump administration. These actions include new penalties for intellectual property infringements, a temporary reduction of tariffs on US auto imports, and the resumption of purchases of US agricultural products. We are encouraged by these measures and believe that they increase the odds that the current negotiation deadline will be extended, assuming a deal is not reached beforehand. A resolution to this issue could go a long way towards improving investor sentiment, as in our view the slowdown in global growth is the number one risk factor currently facing capital markets. An agreement between the world’s two largest economies should help to alleviate global growth concerns.

Portfolio Review

Over the last few months, we have steadily shifted our portfolios towards a more late-cycle positioning. We added some exposure to holdings that we believe could outperform in an economic downturn, and have pared back on shares of what we view as higher risk companies with greater financial leverage. We increased our portfolios’ holdings of large-cap and value stocks, and raised modest levels of cash. In addition, where applicable, we added exposure to long-dated zero coupon US Treasury bonds, as we believe that these securities can be an effective hedge in the event that stocks continue to fall, causing investors to seek out safe-haven assets.

While we enhanced the defensive characteristics of our portfolios in aggregate, we purposefully maintained some exposure to higher beta holdings to reflect that we are cautious, but not overly bearish on the market. As always, we are closely monitoring key market risk factors and stand ready to adjust our positions if needed.


We currently hold a cautious outlook on stocks. We expect that tighter financial conditions and the slowing global economy will be incorporated into the 2019 guidance that may companies will soon be providing, which could make for a choppy earnings season. This coincides with a chaotic domestic political environment, as the Trump administration continues to experience high levels of turnover. In recent weeks, Chief of Staff John Kelly and Secretary of Defense James Mattis have announced their departures, the latter coming in the wake of President Trump announcing his intentions to pull US troops out of Syria. Meanwhile, it appears little progress has been made regarding ending the US government shutdown, and the longer it persists the greater the likelihood that it will weight on investor confidence. Finally, crude oil prices have fallen to a pivotal level, as further declines could weight on capital investment and creditworthiness in the space. While this may be a positive development for the consumer, we think that the aggregate impact of lower oil prices would be detrimental to the economy at large.

Our reasons for optimism include strength in consumer spending. Consumption is the largest component of US economic output and we are optimistic that its recent strength can be sustained. Moreover, equity valuations appear reasonable, and should global growth expectations begin to improve, valuation multiples could expand. An agreement between the US and China to end the trade war is one development which would likely go a long way towards improving sentiment on global growth. While we are encouraged by China’s recent concessions in this regard, we caution that the situation remains quite volatile and difficult to forecast.

Fourth Quarter 2018 | Fixed Income Commentary

Published on Jan. 24, 2019

Fourth Quarter 2018 | Fixed Income Commentary

Market Overview

The final months of 2018 will likely be remembered across U. S. capital markets for extreme levels of daily price volatility. In fixed income, final year-to-date performance was for most bondholders generally lackluster and uninspired. What slight differences there were between the various market sectors can generally be explained by a simple and straightforward metric-credit quality. Counterintuitively, high returns were achieved in instruments thought to be safer, and low total returns (indeed negative for the year) were provided by investments thought to be more risky. One-to-ten year U. S. Treasury and agency bonds saw annual total returns of about 1.44%; one-to-ten year AA-rated corporate bonds gained around 1.23%; one-to-ten year A-rated corporate bonds gained about 0.14%; and one-to-ten year BBB-rated corporate bonds put in a slightly negative (0.68%) total return. Below investment-grade returns were even more negative.

Caught in the malaise, preferred stocks suffered through one of that group’s worst quarterly performances since the Credit Crisis of 2007-09, most notably with the final three months dragging the sector down to its first negative annual return since 2013. Specifically, the ICE Bank of America Merrill Lynch Fixed Rate Preferred Securities index, after posting a respectable first half, ended the year down around -4.34%, as a result of the dismal fourth quarter’s -4.56% total return. This abrupt shift in performance was tied to a near-perfect storm of short-lived technical factors which were eventually overwhelmed by quickly changing fundamental realities. Technical forces of supply and demand were felt most acutely by the largest exchange-traded funds, but prices were hit across the entire preferred stock universe.

Over the first half of 2018, prices of $25 par preferred stocks benefitted from two key positive supply and demand factors. Inflows into the sector’s ETFs ran noticeably higher than usual mid-year as investors continued a long-term hunt for yield. This prolonged demand coincided with an abundance of higher fixed rate coupon issues being redeemed by corporate treasurers. Preferred stock prices were therefore generally supported by growing demand and dwindling supply—and just as significantly, this took place even as most investors were expecting the Fed to continue to steadily raise short-term U. S. interest rates.

In early October 2018 after Fed Chair Powell said that the Fed was far from done with rate hikes, capital markets responded and investors began adopting a more cautious stance with respect to both stocks and bonds. This took place in the backdrop of increasing trade tensions with China and some signs of weakness in overseas economies. Prices of both stocks and bonds immediately began to discount further interest rate hikes and the ten-year Treasury yield jumped from about 2.81% to almost 3.23% from late August to early October. Prices of fixed rate credit instruments, especially perpetual maturity issues like traditional $25 preferred stocks, are sensitive to this kind of rising interest rate environment and bearish price outlook. A host of additional negative economic events, including falling oil prices, geopolitical uncertainties, and domestic political upheaval, culminating with the Democratic Party’s gains and control of the House of Representatives after the midterm elections, quickly compounded the long-standing complacency which had characterized the fixed income market.

The result appeared to be a significant “flight to quality” by investors, causing the stock market to decline, a widening of investment and non-investment grade credit spreads, and significant preferred stock ETF outflows. All of these factors combined pushed the ten-year Treasury yield back to 2.62% as investors sought out the safe haven of government bonds, while simultaneously depressing the market prices of most fixed and fixed-to-floating rate preferred stocks and reversing the favorable technical trends of earlier in the year.

Performance and Outlook

The Current Income Portfolio remained fully invested throughout 2018 in the investment grade U. S. credit markets, generating current yields generally between 4.50-5.0%. While the fourth quarter brought higher volatility than we expected, our allocation to good quality intermediate-term corporate bonds, $25 par preferred stocks and $1000 fixed-to-floating rate preferred stocks helped stabilize the portfolio and mitigate price declines relative to the intermediate-term bond index. The corporate bond component of the portfolio was constructed to provide price sensitivity (as measured by duration) considerably less than intermediate corporate bond indices. This strategic decision also helped to buffer the portfolio from the fourth quarter’s volatility.

Our decision to incrementally upgrade some of the portfolio’s corporate bonds to A-rated from BBB-rated bonds during the year also helped minimize the fourth quarter price volatility. In addition, our decision to shift the preferred allocation of the portfolio to both higher coupon issues as well as fixed-to-floating rate issues also helped performance of the portfolio. Lastly, incrementally shifting the portfolio’s preferred allocation toward $1000 par preferred stock issues also generally helped stabilize the portfolio while at the same time providing significantly enhanced levels of current income compared to what is typically offered in the investment grade credit space.

By mid-January 2019 as we conclude this letter, market prices in the preferred stock market have already recovered much of their exaggerated year-end decline. The underlying question we are left with as fixed income investors after the closing months of 2018: does credit quality deterioration, investment grade credit spread widening, anxiety over monetary policy, and a flight-to-quality revival continue, or were the final weeks of the year instead an opportunity for productive portfolio repositioning? Holding true to our investment objectives, we believe that enhancing current income as opportunities present themselves remains the most reliable way to maximize longer-term wealth creation. Rather than speculate on the credit market nuances ahead, we prefer to conserve as much principal as possible while maximizing the current income improvements available for the clear and present taking. Our approach is to remain focused on annual expected cash flows, and so we tend to welcome (not fear) wider credit spreads as we welcome (not fear) higher ( “normal” if you prefer) nominal interest rates.

Third Quarter Equity Commentary

Published on Nov. 13, 2018

Third Quarter Equity Commentary

Market Overview

Stocks continued to move higher during the third quarter, as the S&P 500 gained 7.2%, its best performance since the fourth quarter of 2013. Investors were encouraged by healthy economic data, strong corporate profits, and some headway on international trade deals. While we are cognizant of risk factors such as trade issues with China and Italy’s budget deficit, we believe that markets can continue to advance as we head into what has historically been a seasonally strong period for equities.

Trade has been a key source of risk for markets since President Trump took office with his ‘America First’ platform. Recently though, significant strides have been made in this regard. President Trump announced the negotiation of a new North American trade agreement that would include both Canada and Mexico, and negotiations are currently taking place with the European Union and Japan. As well, the US recently signed a revised trade deal with South Korea.

To what extend these recent successes may foreshadow a potential agreement with China however, remains to be seen. The US recently imposed another round of tariffs on $200 billion of Chinese imports at a rate of 10%, which could increase to 25% next year. China immediately retaliated by implementing tariffs on $60 billion of US exports into the country. President Trump has threatened to escalate the trade skirmish by extending the tariffs to include all Chinese imports into the US, an estimated incremental $267 billion of goods. While we continue to view this issue as a risk factor for capital markets, we do not believe that the tariffs that are currently in place will meaningfully detract from US or global GDP. We therefore remain optimistic that stocks can continue to climb this wall of worry, though we are continuing to closely monitor the situation.

Italy recently submitted its budget to the European Union, which included an estimated deficit of 2.4% of GDP. Italian markets sank on the news, with stocks down approximately 3% and government bond yields rising 27 basis points. Investors worried that the projection left little margin for error as compared with the EU’s 3% deficit guideline. While this remains a potential flashpoint for European capital markets, we see little reason to anticipate much in the way of contagion for US stocks. In the years subsequent to the financial crisis, US banks have undergone stress tests, shorn up their balance sheets and bolstered their capital ratios. We think this helps explain why US stocks held up well in the aftermath of Italy’s budget submission. While this remains an issue that could inject further volatility into European markets, we do not expect that it will adversely impact US equities.

The Federal Reserve held its latest meeting in September, and as was widely expected, hiked rates by 25 basis points to a range of 2-2.25%. Projections for future rate increases are unchanged, with the Committee calling for another five 25 basis point rate hikes through the end of 2020. While some analysts were surprised by the removal of the word ‘accommodative’ from the statement, Chairman Powell diffused these concerns in his press conference by stating that he still considers policy to be accommodative, recent rate hikes notwithstanding. Despite this seemingly dovish observation, we believe that some investors were more focused on Powell’s confidence that the Fed will meet its projections for future rate increases. In this regard we note that the 10-year Treasury yields have continued to advance and currently sit at cyclical highs. We believe this is a risk factor which bears close attention as there is a threshold at which higher rates may begin to negatively impact economic growth and equity valuations. At the moment, however, we view the recent rise as a positive development with respect to it steepening the yield curve. The flattening yield curve has been a key concern for some market participants who believe that it is flagging recessionary conditions ahead.


We hold a constructive outlook on the market, as we continue to believe that a healthy economy and robust corporate profits should bode well for stock prices. GDP expanded at a brisk 4.2% clip for the second quarter, and while that level of growth is likely not sustainable, we think that solid economic activity continued into the third quarter. Consumer confidence recently hit its best level since 2000, and with unemployment at historically low levels and wages moving higher, we believe that consumption is well set up to help drive future economic activity. The corporate sector has been a key source of strength, with profits rising by 25% on a year-over-year basis for the second quarter. Analysts are predicting another impressive showing for the third quarter, with consensus estimates calling for profit growth of approximately 20%, which we view as achievable.

The trade spat with China remains a key risk for stocks. While we believe that the tariffs currently in place will not materially dent US growth, further rounds of tariffs and more retaliatory actions out of China could rattle investor and corporate confidence. Next month’s midterm elections could also potentially inject some volatility into markets. Depending on the outcome, it is possible that Democrats will be better positioned to challenge President Trump’s agenda; however, we note that many Democrats are aligned with Trump on certain key economic issues such as infrastructure spending and the new North American trade agreement. Moreover, the policy items that are likely most important to capital markets, tax cuts, and deregulation, have already been implemented. We therefore do not expect that the midterms will create material headwinds for stocks.

Lastly, interest rates and inflation, to the extent that they increase faster than currently anticipated by investors, pose a risk to the stock market. While we continue to closely monitor these risk factors, we are encouraged by what we see as a largely healthy fundamental landscape, and we think that the path of least resistance for stocks remains higher at the moment.

Third Quarter Fixed Income Commentary

Published on Nov. 13, 2018

Third Quarter Fixed Income Commentary

Market Overview

One’s investment perspective, how long market positions are likely held, is an underlying aspect of all investment strategies. Institutional bond managers, such as insurance companies and large pension funds, extend their investment perspective over many years to match against their similarly long-dated liabilities, while at the opposite extreme of the investment timeline are speculators whose investment perspective may be measured in minutes. As a result of these completely dissimilar perspectives, different reporting systems are required and deployed. The prudent speculator is forced to mark a trading portfolio daily if not even more frequently, while the institutional bond managers may not even utilize a mark-to-market system of accounting at all, and simply hold the asset-liability yield differential until maturity.

Even within the broader cohort of institutional fixed income investors, there are subgroups with striking differences in their investment philosophies. Many fixed income investors primarily seek steady and sustainable income through a variety of asset exposures; however income-oriented investors might typically hold a single asset class, investment grade bonds, in order to achieve their specific objectives. The income investor often faces a conundrum of having to balance a short-term need for regular –monthly or quarterly—income generation to meet cash flow obligations, and at the same time, the much longer-term perspectives that comes with the understanding that their income needs will extend for many years into the future, and so they need to plan accordingly.

Historical Market Review

Our Current Income Portfolio is designed with the income-oriented investor’s dual investment perspective in mind. The strategy is devised to produce the highest current income characteristics (short-term perspective) while simultaneously applying our best efforts to protect the portfolio’s principal value (longer-term perspective) in order to:

  • Continue income flows over long time periods;
  • Retain abilities to increase today’s income levels (longer perspective) if and when US interest rates rise.

Rising interest rate expectations (called normalization by the Federal Reserve Board policymakers) have been with all investors for a rather extended time period now. Starting at the end of 2016, the FOMC has slowly and steadily reversed the extraordinary low interest rate policies employed to stabilize the economy after the Financial Crisis of 2007-2008. The short-term interest rate target set by the Federal Reserve Board has been raised eight times, with several more on the expectation horizon. And while that may at first seem extraordinary, a historical perspective may be help evaluate where we have been and where interest rates may in fact settle.

Since the beginning of 2017, the two-year US Treasury has risen about 180 basis points, to end the third quarter yielding 2.81%. Over the same period, the 10-year US Treasury has risen only about 50 basis points, to close the third quarter yielding around 3.00%. Despite the Federal Reserve’s ongoing reversal of short-term rate policy, these market rate changes, indeed the nominal interest rates themselves, hardly seem overwhelming. In fact, the relatively anemic total rates of return for bonds over the recent past stem not from price markdowns as rates rise as much as they do from the historically tiny yields the investment grade bond market has been confined to since 2015. Still, from a historical perspective, and mindful of the Federal Reserve Board’s normalization objective, there indeed may be more upside to nominal interest rates ahead of us. The average two-year US Treasury since the 1980s has had about a 5.3% yield, and the average 10-year US Treasury yield has been about 6.7%. It’s important to note that the 80s included the hyper-inflationary era of double-digit interest rates; however no one is predicting a return to that sort of environment any time soon.

The challenge, therefore, is to determine not only how much higher “normal” rates may be from today’s levels, but of equal importance, how much time will pass before we arrive at normal. In the credit markets, especially to income-oriented investors, the latter question may actually be more important than the former.


To best meet our objective of capital preservation paired with the highest level of current income, we have most recently relied on a portfolio constructed with three distinguishing components:

  • A conservative mix of investment grade corporate bonds, diversified across many industries and with a significant weighting of bonds maturing in less than three years,
  • A sleeve of preferred stocks which meaningfully enhances the portfolio’s yield and income characteristics,
  • Utilization of securities which initially pay coupons with attractive fixed interest rates and then either convert to floating interest rates linked to prevailing interest rates or are called at par.

To date, this portfolio structure continues to produce relatively attractive income levels with subdued price changes relative to intermediate-term corporate bonds indices which have higher interest rate sensitivity. Moreover, the fixed-to-floating rate issues have proven less price volatile than the traditional fixed rate alternatives. While it is true that longer-dated portion of the Current Income Portfolio may prove more price volatile in the short-term than the corporate bonds maturing over the next 2-3 years, the income and yield-to-maturity characteristics of the longer dated, fixed investments are dramatically higher today—and may stay so for quite a long time into the future as the market waits for Federal Reserve policy to achieve normalization.

Beyond the portfolio’s current structure, it remains an actively traded portfolio, which in this case refers to our ongoing search for incremental improvements to our portfolio’s characteristics. Through the occasional substitution and replacement of existing holdings for better alternatives, we anticipate we may have the opportunity to significantly enhance income generation. While we foresee the general three-part construction of the Current Income Portfolio remaining much the same as long as the investing environment (Fed tightening, economic growth and low inflation expectations) remains on its current path towards normalization, temporary market distortions and pricing inefficiencies will provide opportunities to improve overall portfolio yield and income characteristics. In recent weeks we have been availing ourselves of such opportunities to improve portfolio yield for our clients.

Healthy Economic Data and a Good Start to the Second Quarter Earnings Season

Published on Sep. 12, 2018

Healthy Economic Data and a Good Start to the Second Quarter Earnings Season

Market Overview

Healthy economic data and a good start to the second quarter earnings season lifted stocks during July, as the S&P 500 achieved a total return of 3.7% for the month. While trade concerns continue to be a focal point for investors, there may have been some progress made, at least with our European partners. We maintain our favorable longer-term outlook for the market, though we remain concerned that ongoing trade disputes may cloud the near-term picture.

The economy continues to exhibit signs of strength as second quarter GDP increased by 4.1%, marking the best pace since Q3 2014. For the first half of 2018, the economy grew at approximately 3% which we view as a solid number, particularly in relation to the subpar GDP growth which has persisted over the last several years. The consumer in particular appears to be in good shape. Consumption grew by a healthy 4% during the quarter, perhaps buoyed by a still strong labor market. During June, a greater than expected 213,000 jobs were added to the economy, this following on the 244,000 additions for May. Consumer sentiment also remains strong, as evidenced by Bloomberg’s Consumer Comfort metric which is near its best level for the current cycle. We also note that the savings rate was revised meaningfully higher, which can facilitate greater future consumption thereby potentially lengthening the economic cycle.

One area that appears to be weakening is the housing market. Housing starts tumbled 12.3% during June, while permits fell 2.2%, both numbers coming in well below consensus estimates. Existing home sales also disappointed in June, declining by 0.6%. Still, as evidenced by the second quarter performance, the economy is weathering the slowdown in this area nicely. While we will continue to watch this space closely, we maintain our positive stance on the economy as most other key sectors continue to perform quite well.

The corporate sector remains robust. With over 80% of companies in the S&P 500 having reported second quarter earnings, 85% of companies are beating profit estimates. Second quarter profits to date have grown by 25% on average. While some of this is clearly the result of tax cuts, what we find impressive is that revenue is also growing at a robust rate; to date second quarter revenue growth has been 10% on average for the S&P 500 index. As a result, consensus 2019 S&P 500 forecasts have moved up to $177, which puts the market’s forward PE at what we view as a reasonable 16x.

Turning to trade, President Trump recently met with European Commission President Jean-Claude Juncker. While the sit down yielded little in terms of tangible results, Trump’s far less antagonistic and more conciliatory tone was notable. Perhaps most important was the intention to refrain from the implementation of any new tariffs, which would take President Trump’s proposed auto import tariffs – which have been widely panned even by hawkish members of the administration – off the table for the time being. While more needs to be done to resolve our trade disputes with Europe, this meeting can be seen as a positive step, if only that both sides displayed a willingness and desire to deescalate tensions.

There has been less progress with regards to trade negotiations with China. The US is in the process of imposing tariffs on an additional $200 billion of imported Chinese goods, though this will not go into effect until after a late August comment period. Prior comment periods have led to exceptions which have reduced the overall dollar amount of targeted goods, so the $200 billion objective could be lessened, assuming it is levied at all. Conversely, the President has threatened to levy tariffs on all Chinese imported goods into the US, so at the moment it is difficult to ascertain what the ultimate amount of tariffs will be. Trade-related uncertainty is a primary factor keeping us from taking a more bullish a view on stocks, as it could add to market volatility until these disputes are settled.


We continue to hold the view that stocks look more appealing over the longer-term, while the short-term appears more uncertain due to ongoing trade disputes. Still, we are optimistic that trade issues can be resolved before lasting damage is done to the global economy; should this occur, we expect that investor attention will shift back to strong underlying fundamentals. In our view a strong labor market, elevated savings, and positive sentiment should bode well for consumption moving forward, the biggest driver of the US economy. Moreover, with inventories currently sitting at low levels, we believe that companies will need to restock which should provide a boost to economic activity. We believe that all of these factors should continue to support good corporate profit growth, and may provide a tailwind for equities to move higher.

We view trade disputes as the key risk to capital markets currently. If our optimism proves to be unfounded and these issues persist, or worse are exacerbated by more rounds of tariffs, it is likely that investors will perceive threats to continued global economic growth, and capital markets may become quite turbulent. While the tone of negotiations with Europe as well as our North American neighbors appears to have improved, there is more to be done, and relations with China still seem stressed. We will of course continue to closely monitor these developments, and as always we are prepared to take further precautions with our portfolios should conditions deteriorate.

Stocks Continued Their Ascent During August 2018

Published on Sep. 12, 2018

Stocks Continued Their Ascent During August 2018

Market Overview

Stocks continued their ascent during August, as the S&P 500 hit a new all-time high and investors were encouraged by robust corporate earnings and some progress on trade. We continue to believe that strong fundamentals bode well for equities over the medium to longer term, although we would like to see more headway on trade before taking a more bullish stance.

US corporate profits continued their strong run during the second quarter, with the Commerce Department reporting after-tax profits rose 16.1% on a year-over-year basis – the best result in six years. On a per-share basis, S&P 500 aggregate earnings grew by nearly 25%, a threshold reached only once since 2010. While lower taxes were one source of strength, sales were also quite strong growing at 9.5%, indicating that underlying business conditions remain robust. We are encouraged by these results and believe that corporate profits should remain healthy for the foreseeable future, driven by supportive economic conditions.

Trade remains a wild card, particularly with China, where key issues are yet to be resolved and the Trump administration is contemplating further rounds of tariffs. However, some progress has been made with Mexico, as President Trump and President Nieto announced an agreement on aspects of a trade deal. We are encouraged by this pact, as in our view it demonstrates a desire on the part of the US to work with its partners and avoid costly trade wars. While there is more to be done in this regard, we view the discussions with Mexico as a step in the right direction.

Turkey became a focal point for global investors in recent weeks as its currency collapsed and government yields skyrocketed due to concerns about the country’s debt profile, persistent current account deficits, and perceived lack of central bank independence. While we view the situation as quite serious for the Turkish economy, we do not expect much in the way of contagion. Among emerging market economies, we view Argentina as the only other country which is similar to Turkey in terms of debt load and lack of foreign reserves. We think this explains why most other developing country capital markets have held up well despite the massive depreciation of Turkey’s currency. Moreover, we see some similarities to the collapse of the Russian ruble in 2013 following the country’s annexation of Crimea, and note that in that instance there was no meaningful contagion to other major capital markets.

Turning to monetary policy, Fed Chairman Jerome Powell made some dovish remarks at the recent Jackson Hole Economic Policy Symposium. Powell spent some time addressing why inflation might remain persistently low during the current economic cycle, and commended former Chairman Allan Greenspan for his measured pace of rate hikes when he presided over a similarly low inflation environment. He also spoke about how the Fed is trying to ascertain the appropriate neutral level of interest rates for the current cycle, and stressed caution in making this determination. In our view, all of these remarks are consistent with a central bank which is attempting to prudently navigate a measured rate hiking campaign, so as to minimize any disruption to the economy and capital markets.


We remain optimistic on stocks and believe that strong fundamentals should help support higher prices over the longer term. Corporate earnings have been robust, and we expect that a healthy economy will continue to sustain strong profits moving forward. We note that second quarter GDP growth was revised up to 4.2%, marking its best performance in nearly 4 years.

While most of the economic indicators that we track appear favorable at the moment, the slope of the Treasury yield curve is a notable exception. Currently hovering near 10-year lows, some investors are concerned that the flattening yield curve may be signaling the next recession. In our view, while a yield curve at this level is a concern, when viewed alongside other indicators we do not believe that a recession is imminent. Some of the other metrics that we believe counter the pending recession narrative include good freight volumes, sturdy retail sales, and tight corporate credit spreads.

For the short-term, our view is more tempered, primarily due to the continuing trade dispute with China. We believe that until this situation is resolved, investors will be hesitant to fully price in what we view as strong underlying fundamentals. Other factors keeping us cautious over the near-term include Italy’s upcoming budget submission to the European Commission, as we believe the two parties have contrasting views on Italy’s budget deficit and that the situation could negatively impact capital markets if the submission were to be rejected. Finally, the calendar may also be a headwind, as September has been the worst month of the year for stocks historically.

Second Quarter 2018 Fixed Income Commentary

Published on Aug. 2, 2018

Second Quarter 2018 Fixed Income Commentary

Market Overview

Over the course of 2017 and the first half of 2018 the Federal Reserve has raised interest rates. In June, the federal funds rate was adjusted upwards to a 1.75 – 2.00% target range. This has been the seventh 25 basis point increase by the Fed since December of 2015.

A change in leadership at the Federal Reserve Board’s FOMC did not appear to alter the committee’s long-standing, public commitment to “normalize” US interest rates, especially on the short-end of the yield curve. After nearly a decade of historically aggressive and prolonged accommodative monetary policy to aid recovery from the financial crisis, the time had come to begin a tightening of monetary policy. We believe this shift reflects the Fed’s view that our economy has definitively moved off of life support and back to good health.

Longer-term rates, in contrast, have not moved upwards with the same alacrity. After touching 3.11% in mid-April and late-May, the 10-year US Treasury yield ended the quarter at a yield of 2.85%, consistent with its level in February 2018.

This has us questioning the direct impact on market rates and the yield curve, with the Fed’s engineered rate increases. We are inclined not to be too focused on interest rate anticipation strategies, as prognostications of higher market rates haven’t borne out. Instead our more tried and true approach has been effective. That is to remain fully invested, yet well positioned to take advantage of higher yields, should they materialize. Our approach is to build client portfolios with the most attractive levels of internal cash flows while limiting traditional bond market risks as reasonably as possible.

We believe it’s possible there will be three, maybe even four, rate hikes a year over the next two years, after which point- federal funds rate would then reach 3.25 – 3.50%. Under this scenario, the 2-year US Treasury would likely see 4.00%, and the 10-year US Treasury would trade at 4.00 – 5.00%, possibly higher. This is how we could see the domestic credit market attain “normalcy.” US 10-year-note yields have barely nudged higher from a year ago. This market benchmark, rising only slightly with successive Federal Reserve actions in the short-term market, bounced off a temporary flirtation with 3.0%, but quickly returned to about 2.85%, the identical levels seen for 10-year Treasury notes back in 2013. This leaves the possibility of a 4% 10-year note suddenly further away than it may have seemed to most investors, proving how difficult it can be to forecast interest rate changes with much certainty at all, especially in the short-term.

The surprises for interest rate forecasters so far in 2018 reinforce the potential pitfalls that may be unnecessarily created from abruptly straying from your investment philosophy and process, solely in reaction to volatile news cycles or wavering expert opinions and prognostications. A consistent approach, matching risks to potential rewards, remains an invaluable virtue across most investment enterprises, and we believe it is especially necessary to maintaining long-term success in fixed income management.


We have not strayed from our core objectives or disciplines, and have remained fully invested and well-positioned to take advantage of more generous yields on the expected horizon. As a result, our portfolios have continued to produce attractive levels of current income levels and relatively generous internal cash flows, while maintaining relatively stable market values. We believe we will have to be a bit more patient than original contemplated to see our way through short-term price volatility to the realizations of longer-term planning.

Late last year we opted to select shorter rather than longer maturities for reinvestment operations. This has proven helpful to dampen price volatility relative to the overall market, since bond prices have declined as interest rates have moved higher. In this regard, the first half of 2018 has not been particularly kind to investment grade, intermediate-term US corporate bonds. Corporate bonds underperformed government bonds in the second quarter, continuing the trend experienced in the first quarter this year.

Similarly, we opted for a more defensive investment approach by moving a portion of the portfolio from BBB-rated issuers into similar maturity investments with A-ratings. This approach has helped moderate the price decline of our income portfolio this year as higher rated corporate issues have outperformed lesser quality issues. In fact, since early February the yield spread difference between an index of BBB-rated corporate bonds and the US 10-year note has steadily widened from 1.20% to 1.64% at the end of June.

We maintain a sleeve of investment grade preferred stocks as a key component of our income investment strategy, albeit to a limited allocation of approximately 24%. We continually weigh the structural risks and potential rewards of these fixed income investments against alternative investment grade sectors. We have elected to increase our portfolio’s use of fixed-to-floating rate preferred securities as opposed to fixed rate, traditional preferred stock issues. We believe that the variable rate structures offer flexibility to maximize opportunities afforded by higher nominal interest rates, should they become available. In the meantime, the fixed rate preferred stocks have also added to our portfolio’s year-to-date performance.


Federal Reserve Chairman Powell recently re-confirmed the FOMC’s present intention to gradually raise the federal funds rate. Economic conditions at present are quite healthy, but may change at any time. We remain committed to implementing our current approach and remaining steadfast to our income–oriented portfolio’s long-term strategy. This approach allows us to best preserve capital and retain significant ability to reinvest at higher interest rates should they become available.

Second Quarter 2018 Equity Commentary

Published on Jul. 19, 2018

Second Quarter 2018 Equity Commentary

Market Overview

Stocks advanced during the second quarter, with the S&P 500 gaining 3.4%. In our view, this was mainly due to a healthy domestic economy and strong corporate profits, which offset rising concerns over international trade. However, markets may see a pickup in volatility until trade disputes are resolved and uncertainties abated. Therefore, our near-term view is more guarded, but we remain hopeful that trade wars can be averted and maintain our constructive longer-term outlook.

Trade issues have dominated financial headlines in recent months as the US has enacted fresh tariffs on many key global economies, most of which have responded in kind. Fortunately, the tariffs implemented thus far have been relatively minor and in our view are not likely to cause significant economic damage. However, President Trump has threatened additional tariffs on up to $400 billion of Chinese imported goods, but many economists believe this threat is not credible given the collateral damage it could do to US companies that manufacture goods in China. While we agree with this assessment, we think that investors should still consider the possibility that additional layers of tariffs may be implemented. How many and to what extent are key unknowns that will likely play a large role in determining the market’s performance in the months to come.

Certain companies are already seeing an impact from newly enacted tariffs. Harley Davidson announced plans to move some of its manufacturing outside of the US in order to avoid European tariffs on US based exports. In the interim, the company will face higher supply-chain costs but at this point it has been an outlier as few other companies have noted these types of headwinds. We would however expect markets to react negatively should more companies come out with tariff-induced profit warnings.

The tailwinds of growth in the US economy have not been broad-based and instead have concentrated in growth and small capitalization stocks, which may be more immune to the market risks that have captured investors’ attention. Our inclination is that smaller companies may continue their outperformance, particularly if trade concerns persist, and could act as a natural hedge and outperform should the broader market decline because of investor fears about trade conflict or slowing growth outside the US.


We currently hold a nuanced view on the market. Our foundational outlook continues to be that cooler heads will prevail and that the bulk of the tariffs that have been threatened will not be implemented. We expect that investor attention will ultimately shift back to economic fundamentals which have been strong in the US, enabling stocks to move higher over the medium- to longer-term. Consumer confidence, while off of its highs, remains at healthy levels, and surveys of the manufacturing and service sectors have strengthened. Many economists are projecting GDP growth of over 4% for the second quarter, which would be quite impressive in our view. Meanwhile, corporate earnings have been robust and we expect this trend will continue during the upcoming second quarter earnings season.

For the near-term, we are more cautious. It is possible that trade issues will persist and we believe that the associated uncertainty has been weighing on capital markets. While domestic stocks are up on a year-to-date basis, we think that the gains have been quite modest given the stellar pace of corporate profit growth. Moreover, the yield curve has continued to flatten with the spread between the 2-year and 10-year Treasury yields now hovering near a decade low. In our view, absent trade related uncertainties, stock markets would be trading higher and the yield curve would likely be steeper.

Trade uncertainties could also exacerbate certain geopolitical risks. South Korea has intimated that if the Trump administration were to apply tariffs on automotive imports, it would step back from its role in the US-North Korea denuclearization talks. While capital markets were not impacted earlier in the year when the relationship between President Trump and Kim Jong-un was openly hostile, they could still be at risk if the situation were to deteriorate. With trade tensions potentially impacting geopolitics during a period in which nationalism has been on the rise globally, we think that the near-term risks for multinational corporations are elevated. As such, we remain optimistic that these tensions will ultimately cool but as always, we are prepared to take further risk management actions should conditions change.

May Markets Trump Along Despite Trade Talks and Italian Politics

Published on Jun. 8, 2018

May Markets Trump Along Despite Trade Talks and Italian Politics

Market Overview

Despite turbulence in trade negotiations and Italian politics, US stocks enjoyed a strong May, with the S&P 500 advancing 2.2%. With seemingly improved economic activity following a subpar first quarter of 2018, we expect corporate profits will remain strong and we maintain our positive outlook on the market.

Trade remains a focal point for investors. US aluminum and steel tariff exemptions expired for the EU, Canada, and Mexico, and the Trump administration announced tariffs would be imposed on certain imported Chinese products starting on July 1st. Meanwhile, the failure to make progress with NAFTA negotiations has dimmed the prospect of reaching a deal by year end. Although we are seeing retaliatory tariffs imposed on US exports, we do not believe that these actions will have a materially adverse impact on US economic growth. However, the uncertainty of Trump’s rhetoric and capricious negotiating tactics may create a challenging environment for corporate management to make long-term capital investment decisions.

Trade related headwinds aside, US stocks have been quite resilient. In our view, a strong economy and positive corporate earnings have created a buffer against negative trade headlines. We believe that investors are viewing most of the White House’s rhetoric as means of negotiation, and that the President’s positions may suddenly change. Therefore, we think markets are reacting less to policy announcements and are waiting on concrete policy action.

Italian politics briefly rattled capital markets after President Mattarella vetoed the 5 Star and League party’s choice for Minister of Economy and Finance. Amid the uncertainty of whether Italy would be able to form a coalition government, Italian 2-year government bonds had their worst day since 1989 (when Thompson Reuters began tracking the data), as yields jumped more than 150 basis points to close at 2.4%. Upon reaching a compromise that keeps the coalition government intact and avoids the potential for snap elections, Italian bonds recovered as 2-year yields retraced nearly half of the advance from the previous day.

We believe that the odds of an Italian exit from the Eurozone are low and we will continue to monitor the situation, but we are not overly concerned by the dramatic headlines. Another potential issue to consider is whether the country’s bonds might have to be restructured, although we view this as unlikely over the near- to intermediate-term. Moreover, we would not expect US capital markets to be directly impacted in the event of a restructuring, since the majority of Italian government bonds are held by Italian citizens and European banks. However, we are cognizant that some degree of contagion might transpire.


We continue to hold a positive view on the market and expect that a healthy economy will help to sustain strong corporate profits. In recent years, economic growth has slowed during the first quarter, and recent data suggests that growth is progressing. Regional Federal Reserve surveys aimed at capturing economic activity in various parts of the US have been robust, and forecasts for second quarter GDP growth are in the 3-4% range. Additionally, while we have yet to see a meaningful impact from the recent tax reform, we expect that it will soon give a boost to both corporate investments and consumer spending.

A key risk for markets in our view is trade, as we see the tariff announcements as potentially increasing trade friction with multiple countries. As noted, we think that capital markets can continue to show resilience despite these risks, given a healthy economy and strong profits. However, if the situation were to escalate, we expect that markets would price in weaker fundamental conditions, putting stock prices at risk. We are also keeping close tabs on inflation, as a sharp pick-up could compel the Fed to raise interest rates at a faster pace than markets are currently expecting. This could curtail GDP growth, leaving the economy more vulnerable to exogenous shocks, such as the aforementioned potential trade negotiations. Fortunately we are not yet seeing any signs that inflation is rising to levels that would force the Fed’s hand in this regard.

Stocks Log Modest Gains in April

Published on May 10, 2018

Stocks Log Modest Gains in April

Market Overview

Stocks logged modest gains in April, with the S&P 500 gaining 0.4%. While the economy continues to expand and earnings have been strong, we think some investors are concerned that the flattening yield curve may be signaling the end of the current economic cycle. In our view however, there is not yet sufficient data to support this thesis, and we maintain our positive outlook for the market.

Corporate earnings appear to have continued their positive momentum from the first quarter. As of this writing, with just over half of S&P companies having reported first quarter earnings, 80% have exceeded consensus profit expectations by an average margin of 7.3%. While some of these results are due to lower tax rates, revenues too have been strong, with 70% of companies having exceeded top line estimates. Overall, we view these results as quite robust and believe that they reinforce our thesis that strong profits can continue to carry stocks higher.

Our view notwithstanding, stocks have not reacted as positively to earnings results as would typically be the case. However, we believe that this reflects more about sentiment than underlying fundamentals. Investor expectations may have been overly aggressive with respect to the cadence of benefits from the recently enacted tax cuts. While the full impact to corporate income statements may not be as front-end loaded as investors initially believed, in our view, there is little to suggest that this is anything more than a timing issue.

Perhaps of greater concern arising from the current earnings season is the question of where we are in the current economic cycle. Caterpillar’s management team rattled markets by suggesting that its profits in the coming quarters may not reach the level achieved during the first quarter of the year. Some investors extrapolated from this comment (along with other indicators, such as the narrowing yield curve) that perhaps we are at or are nearing the peak of the market cycle. This is an important consideration with regards to ascribing an appropriate market valuation multiple.

Investors are generally more comfortable bidding up stocks to higher P/E multiples if the expectation is that earnings will be growing in future years. However, at peak earnings, market multiples typically fall as investors price in future profit declines. In our view, we do not see sufficient evidence to conclude that we are nearing the end of the cycle. While Caterpillar is a large industrial company that tends to have good visibility on macro trends, it is still just one company and its views were not confirmed by many other large industrial companies that we also follow. Moreover, the issue of the tax cut benefits not being overly front-end loaded would actually argue for a longer cycle, as the full benefits are realized over time.

Trade continues to be a focal point for investors, particularly the ongoing negotiations between the US and China. Over view is that the Trump administration would prefer not to impose tariffs on massive amounts of Chinese imported goods, and that the rhetoric in this regard was more likely a negotiation tactic. We therefore remain optimistic that a damaging trade war can be averted. There has been some trade progress made already, as China has discussed its willingness to allow foreign firms greater access to its financial and automotive industries. We also note that NAFTA talks appear to be moving forward, with Mexican officials recently expressing confidence that an agreement can be reached in the near future. We think that a successful NAFTA negotiation would boost investor confidence that a deal can be struck with China as well.


We maintain our positive view on the market. Corporate profits are robust, and we believe that a healthy economy will help to support their continued growth. Consumer confidence and small business sentiment remain near all-time highs, and the labor market is strong. We think that these conditions bode well for business activity moving forward and suggest that we are not approaching the end of the economic cycle. Given our expectation for continued profit growth, we find the market to be attractively valued and see room for stocks to move higher.

Market risks that we are monitoring include the trade negotiations with China, and while we remain optimistic that an agreement can be reached, we concede that thorny issues – including technology transfers and intellectual property rights – may yet prove to be stumbling blocks. In the geopolitical arena, oil prices moved higher following President Trump’s announcement that the US will withdraw from the Iran nuclear deal and reinstate Iranian sanctions. Oil prices had already been climbing in anticipation of this announcement, and we continue to monitor the impact of higher oil prices on consumer activity and inflation. Materially higher rates of inflation could force the Fed to accelerate its rate hiking campaign, and potentially roil capital markets. However, while various inflation metrics have come in at or near the Fed’s preferred 2% level, we are not currently seeing any indication that prices are spiraling out of control, particularly with respect to wages. Therefore, we are confident that this risk factor remains in check at present.

Volatility Makes an Appearance in the First Quarter

Published on May 1, 2018

Volatility Makes an Appearance in the First Quarter

Market Overview

The return of volatility took investors on a wild ride during the first quarter of the year. While the overall trend for market yields is higher, several factors complicated the picture this quarter, resulting in market gyrations that kept investors on their toes. We believe historical relationships and trends that have characterized the last several years are beginning to fray, suggesting to us that markets have reached an inflection point. Pattern changes that point to this include unusual changes in credit spreads and the shape of the yield curve, as well as the correlation between stock and bond prices relative to economic activity.

While the past several years have been characterized by accommodative monetary policy, a low-growth economic recovery, and very slight inflation, leading to a persistent flattening of the yield curve and tight spreads, an abrupt reversal occurred mid-February, sparked by labor market data which triggered inflation fears and concern this could prompt the Federal Reserve to accelerate their plans. In March, these concerns abated, and were sidelined by fears of a potential trade war, which sparked volatility in the stock market and precipitated a “flight to safety” in Treasury bonds, driving yields lower. Despite the 10 Year Treasury spiking to a four-year high of 2.95% in February, the yield curve’s overall trend for the quarter was continued flattening.

We view the shape of the yield curve as noteworthy relative to the past five years. The difference between the US Treasury 2-year and 10-year notes has compressed throughout the economic recovery from the financial crisis, ranging from a modest 0.50% to over 2.50%. Interest rates on both short- and long-term US bonds have been rising as the Fed continues its slow and steady approach toward a more normalized rate environment. However, the ascent is following a bear flattening approach, whereby short-term rates are rising faster than long-term rates. While this may prompt questions on whether an inverted yield curve may be on the horizon, this phenomenon is traditionally short-lived and occurs when recessionary pressures are far more pervasive than what we are seeing right now.

We believe corporate credit markets may be beginning to separate and move in more independent directions. Yield spreads between investment grade corporate bonds and the US Treasury 10-year note had been narrowing steadily for nearly two years, yet this yield spread reached historical narrow levels during the first part of the quarter then reversed dramatically, returning to the yield spreads of mid-2017. Over the quarter, spreads between US Treasury and US corporate issues tightened, widened, and then tightened again. Going forward, we anticipate greater potential for widening.

Based on these observations, our thought is that after many years of bond and equity price changes being tied closely together, the strength of this relationship may be starting to weaken. Instead of bond prices rising and yields declining in tandem with economic good tidings, bond prices may begin to decline while yields rise, independent of equity market fortunes. There are significant trends to consider in support of this inflection point: tightening monetary policy remains in place for further rate hikes, loosening fiscal policy seems likely following plans to expand the Federal deficit, and the yield spreads necessary to compensate lenders for the risks of non-government-guaranteed issues may be expanding.


These new pressures are already presenting challenges in terms of relative performance between US credit market sectors, as demonstrated in the wide range of total returns across sectors for the first quarter. While the ICE BofAML 1-10 US Treasury and Agency Index returned -0.69%, the ICE BofAML 1-10 US Corporate Index returned -1.46%, and the ICE BofAML Fixed Rate Preferred Securities Index returned -1.00%.

The Roosevelt Current Income Portfolio (“CIP”) remains focused on providing the highest possible current income investment characteristics while assuming the least amount of risks. While total rates of return (over longer investment periods) remain an important measurement of wealth creation, and a cornerstone of our underlying process and strategic decision-making, the CIP strategy is focused primarily on maximizing current income through a reliance on a relatively patient and conservative approach.

At the end of 2017, we reduced the portfolio’s overall duration (interest rate risk) as well as its allocation to preferred stocks, while shifting the allocation towards fixed-to-floating rate preferred structures. These adjustments helped to moderate a slightly negative total rate of return over the quarter. Equally important, the portfolio is strategically designed to preserve its ability to take advantage of rising rate environments as they become available. A slow drift higher in nominal US interest rates as changes in expectations for inflation and monetary policy manifest remains the most reasonable expectation, in our view. How the markets respond remains fluid, of course, but we continue to maintain our view of greater downside price risks than upside potential, and are conservatively positioned as a result.

Despite Strong Corporate Earnings, Stocks Unable to Sustain Early Gains

Published on Apr. 17, 2018

Despite Strong Corporate Earnings, Stocks Unable to Sustain Early Gains

Market Overview

Stocks were unable to sustain the strong gains achieved during the start of the year, with the S&P closing out the first quarter with a 1.2% decline. While strong corporate earnings buoyed investor spirits, they were not enough to offset concerns regarding potential trade frictions and weakness in technology stocks. Recent volatility notwithstanding, we maintain our constructive view on the market and continue to believe that a healthy economy and robust corporate sector should bode well for stocks moving forward.

Concerns about potential trade wars have been a key focus for investors since President Trump announced his intention to implement tariffs on steel and aluminum imports. While markets initially reacted negatively to Trump’s announcement, investors were assuaged in the ensuing days as it became clear that many international economies would be exempted from these tariffs. However, Trump recently detailed plans to levy tariffs on certain imported goods from China, prompting fears of a trade war between the world’s two largest economies and putting capital markets on edge.

While we agree that a trade war with China would likely disrupt economic activity and result in lower stock prices, we believe that the most likely outcome of this friction is a successful negotiation between the US, China, and other trading partners to address current imbalances. In our estimation, both sides realize that there are no benefits to be had from a trade war, and we therefore view the proposals at this time to be mostly posturing and starting points for negotiation. While the prospect of a trade war with China remains a key potential risk factor, we are cautiously optimistic that it can be avoided.

A separate but related issue pertaining to economic relations with China is the transfer of intellectual property (“IP”). We believe that for some time now, many US corporations have been forced to effectively give away their IP in order to gain access to Chinese markets. In our view, these companies stand to benefit in the long run should the current trade negotiations result in these companies having the ability to start monetizing their intellectual property.

Another headwind facing investors in recent weeks has been weakness in the technology sector. Social media has been particularly vulnerable following recent allegations that political data firm Cambridge Analytica improperly obtained data on millions of Facebook users in an effort to build voter profiles. This has led to calls for greater restrictions and regulations on social media companies, which in turn has investors concerned about the potential impact on future earnings power.

Indeed, damning headlines and the potential for more stringent regulations may negatively impact certain technology companies. However, we also view these companies as having dominant positions in online advertising which at this stage, we believe are unlikely to be materially impacted by regulation. Therefore, while these events have dampened sentiment on the technology sector, we believe that the secular trends that are driving the fortunes of our portfolio remain intact.

Turning to the economy, we remain encouraged by the preponderance of the recent data points. On the consumer front, the University of Michigan’s sentiment index for March reached its best level since 2004, and real consumer spending remains near all-time highs. The ISM’s widely followed survey of the manufacturing space remains near the 14-year best (60.8%) achieved in February. Moreover, during March, the IHS Markit manufacturing PMI accelerated at its fastest pace in 3 years. In our view, these data points provide strong evidence that our economy remains stronger than it has been in quite some time, and we believe that the broadly favorable impact of the Tax Cuts and Jobs Act is still largely ahead of us.


We continue to view stocks constructively, due in large part to the strength in corporate profits. Many analysts are calling for 17% growth in aggregate S&P 500 EPS for the first quarter, and estimates for the full year have increased by a healthy 7% (to $157.77 from $147.24) since the beginning of January. This upward revision in full year estimates is the largest seen during the first quarter of any year since FactSet began tracking the data in 1996. Moreover, the combination of higher profit estimates and lower stock prices has taken the market’s forward P/E ratio (based on 2019 estimates) down to just over 15x as of this writing, a reasonable level very much in line with historical averages.

In our view, key risks to the market include the potential for escalating trade-related tensions, particularly with China. While we are optimistic that cooler heads will prevail, we acknowledge that the potential for a disruptive trade war is higher today than it has been in recent memory. We also continue to keep a close watch on inflation. Investors were rattled earlier in the year when the initial release of the January jobs report showed wages were running ahead of expectations, igniting fears that higher inflation would force the Fed to accelerate their interest rate hikes. These fears have calmed of late though, as both the January and February PCE (personal consumption expenditures) price indices came in below the Fed’s 2% target, and wage growth has moderated from January’s peak of 2.8%. We will continue to monitor these and other market risk factors, and stand ready to shift to a more defensive posture should we deem it prudent to do so.

Corporate Profits Remain Strong Despite Volatility

Published on Mar. 9, 2018

Corporate Profits Remain Strong Despite Volatility

Market Overview

Volatility returned to markets in full force in February, and the reversal of some very crowded trades led to a 3.7% decline for the S&P 500. Macroeconomic fundamentals however, remain sound, in our view. Despite some uneven data points in recent weeks, we maintain our positive stance on the market and continue to believe that strong corporate profits can carry stocks higher.

Stocks corrected in early February. In our view, this was largely a function of equities having been overextended following the run up through January. We believe that the unusually long period of market stability resulted in too many investors crowding into low beta and low volatility strategies, leaving these areas ripe for correction. While sharp declines and surging volatility are not ideal for markets, we currently are not overly concerned, as we view these conditions as largely technical in nature rather than reflecting weakness in underlying fundamentals.

Inflation has been a focal point for investors of late. Markets appeared to be caught off guard by the 2.9% wage growth reported for January, and yields moved abruptly higher in the aftermath. Subsequently, both the CPI and PPI for February printed numbers ahead of consensus expectations. These data points have heightened concerns among certain investors that the Fed may be behind the curve with regards to its interest rate policy and may have to ramp up the pace of rate hikes as a result.

However, we note that while inflation has surprised investors by moving incrementally higher, its absolute levels are still modest by historical standards. Moreover, we would expect that the yield curve would flatten if markets were truly signaling a policy mistake, but that has not been the case. In fact, the yield curve has steepened in recent weeks. Should inflation to move sharply higher from current levels, we would expect valuation ratios to compress and stocks to decline. We are therefore keeping a close eye on consumer prices and other inflation indicators, and stand ready to act should conditions warrant.

President Trump’s decision to impose tariffs on steel and aluminum imports – 25% and 10%, respectively – has rekindled investor concerns about potential trade wars. While some industries will likely benefit from these policies, we believe that they may also have the potential to negatively impact the aggregate economy. That being said, we are more keenly focused on trade as it relates to the NAFTA negotiations, which, while ongoing, grant Mexico and Canada exemption from the tariffs. We are closely monitoring these talks to better understand how US trade will be impacted in the coming years.


We maintain our positive stance on the market. With consumer sentiment strong, job growth continuing apace and wage growth accelerating, we would expect to see healthy consumer spending this year, which in turn should boost overall economic activity. A healthy economic backdrop should help to sustain what has been a very strong period for corporate profits. In this regard, we note that following the robust fourth quarter earnings season, analysts have hiked their earnings estimates for both this year and next. With consensus S&P 500 forecasts now in the low to mid $170’s for 2019, the market’s forward PE is a reasonable 15.5x as of this writing. This is noteworthy as valuations had become somewhat extended in recent months, but the combination of higher earnings estimates and a pullback in the market has left stocks more reasonably valued, in our view.

While we are not concerned with inflation levels at the moment, a potential spike in inflation remains a key risk. The latest CPI reading came in at 2.1% – essentially in line with the Fed’s 2% target – and if sustained, would be quite comfortable for markets, in our view. However, with unemployment having been at very low levels for some time now, it is not difficult to conjure a scenario in which inflation moves materially higher, perhaps exacerbated by the recent tax reform which is expected to give a further boost to economic activity. With bond yields still low by historical standards, we would expect them to move higher in this scenario as well. Most notably, the Fed may have to accelerate its planned rate hikes. While this is not our base case, it is one which would likely roil markets and we will therefore continue to monitor pricing pressures closely.

Strong Start to the New Year

Published on Feb. 13, 2018

Strong Start to the New Year

Market Overview

Stocks began the year with considerable strength, as the S&P 500 returned 5.7% for January. Investors appeared to key in on robust global growth and healthy US corporate profits. While we are keeping a close eye on interest rates, we maintain our constructive stance on the market, as we continue to expect that the combination of strong fundamentals and still easy financial conditions should bode well for stock prices.

The steep increase in Treasury yields has been one of the key capital market developments to begin the year, as the 10- year US Treasury bond recently yielded about 2.8%, up from just 2.4% at the end of December. We think that much of this move has been a reflection of healthy economic conditions, both domestically and abroad. Moreover, the recent rise notwithstanding, yields are still low by historical standards and in our view are not approaching levels which would materially derail economic activity.

However, while the absolute level of interest rates remains subdued, the velocity of the ascent has been disconcerting for investors. If yields continue to climb rapidly, we would expect it to cause perturbations throughout capital markets. With valuations somewhat stretched, equities would likely be vulnerable to a pullback, as for some time now investors have been able to justify higher P/E ratios at least in part due to the low interest rate environment. In summation, a 10-year Treasury yield of less than 3% need not be a headwind for stocks in and of itself. However, a 40 basis point move in one month is a great deal of volatility for the Treasury market, and therefore we will continue to closely monitor it as a source of risk for equities moving forward.

The dollar, which recently fell to a multi-year low, has also been in focus for investors. We view this drop as being favorable for equities, as a weaker dollar typically boosts exports and enhances the profits of US based multinationals. We think that a key factor behind the decline has been healthy international economic growth. Momentum in major foreign economies has led investors to speculate that central banks will speed up their monetary policy normalization, boosting their currencies in the process. We do think there is a threshold after which further dollar declines become counterproductive for stocks. For now though, particularly with inflation remaining low by historical standards, we continue to view the dollar’s weakness as being supportive for stocks.

Fourth quarter earnings season is well underway, and thus far the results have been quite encouraging. With just over 40% of the S&P 500 having reported, aggregate profits are up a healthy 12% – well ahead of expectations for 9% growth – and 81% of companies are exceeding earnings estimates, the highest level in 7 years. Moreover, a record 75% of companies have raised guidance for the year, and while some of this has likely been a function of the recent tax legislation, we think that strong fundamentals are playing a role as well.


We maintain our positive stance on the market, as both fundamental and financial conditions remain supportive, in our view. Global economic growth has been robust and the IMF recently raised its growth estimates for both this year and next year to 3.9%, which would be the best performance since 2011. It is not just the magnitude but the breadth of the growth which has been impressive. Furthermore, 2017 marked the broadest synchronized growth since 2010, as 120 countries representing 75% of global GDP saw higher year-over-year levels of business activity.

While many investors are beginning to anticipate tighter global monetary policies, particularly in Europe and Japan, we continue to view financial conditions in aggregate as being supportive of equities. Market indicators such as corporate bond spreads and the aforementioned weak dollar do not suggest tight conditions. As well, even with certain central banks seemingly poised to pick up the pace of their policy normalization plans, we note that projections for the aggregate balance sheet of the Federal Reserve, ECB, BOJ, and BOE is to be little changed from current levels over the next few years.

As noted, we view any further spikes in treasury yields as the key risk factor for equities currently. Elsewhere, we are concerned about certain pockets of the US economy. Housing, for example, is particularly vulnerable to a higher yield environment as affordability drops with increasing mortgage rates. The industry may also experience some headwinds pertaining to the recently enacted tax legislation, which limits deductions on mortgage interest expense. While we have little exposure to this space in the portfolio at this time, we will continue to monitor these risk factors as they develop.

Impact of the Tax Cuts and Jobs Act

Published on Jan. 29, 2018

Impact of the Tax Cuts and Jobs Act

While it is still too early to fully understand the implications of President Trump’s new tax law, we are seeing signs that the tax changes may have more positive impacts than previously appreciated. Perhaps to no one’s surprise, a lot of political rhetoric accompanied the bill’s debate and passage, and that debate may have obscured what could be positive impacts from the standpoint of the U.S. economy.

One meaningful change is the 40% decline in the corporate tax rate, cut from 35% to 21%. While many companies pay less than the full rate anyway, the reduction is substantial for a company which is actually paying the full 35% rate. Assuming a business generates $1,000,000 of pre-tax income, for 2017 their federal tax would be $350,000, but that will decline to $210,000 in 2018. This hypothetical company just saw its after-tax earnings go up by 21.5% (from $650,000 to $790,000), without any extra investment or hours worked.

In addition to this possible boost in after-tax income, companies which keep cash outside of the US, to avoid paying US taxes on those funds, should benefit from the reduction in taxation on that cash. This reduced tax could cause some companies to bring that money back to the US (sometimes referred to as “repatriating”). For some companies, this benefit will equate to billions of dollars. While this repatriation benefit is one-time, the income tax rate reduction is ongoing.

An important question is what will companies do with the benefits of this tax reform? Some market pundits believe companies will use their extra cash to purchase their own stock or increase stock dividends, or perhaps engage in merger and acquisition activity. Other commenters believe that these companies’ customers and employees could benefit from the tax changes in the form of increased compensation or lower prices.

In fact, we have already seen media reports that over a dozen companies in the S&P 500 index indicated they intend to pay employees a one-time bonus of up to $1,000 and boost hourly wages. We will hear from more companies in the coming weeks as they provide their quarterly earnings reports, and we believe it is possible they too will give guidance on what they plan to do with any extra funds resulting from the new tax changes.

JP Morgan, the largest US bank and one of the first companies to report fourth quarter earnings, provided some detail during a recent conference call of how it would allocate its benefit from tax reform. JP Morgan advised that while it awaits further clarity on the exact details of the tax reform, it expects some or all of the following to take place that would not have occurred absent the tax bill (in no particular order):

some of the benefit will be competed away

  • it will invest in global expansion, new technologies, and opening offices
  • it will increase employee benefits and hire additional bankers
  • it will consider decisions related to dividend policy and share repurchases (keeping in mind that regulators dictate the extent to which banks are permitted to return capital to shareholders)
  • it will consider providing subsidies to low income borrowers and support for small businesses

With respect to benefits being “competed away”, we understand JP Morgan to mean that since other banks are also going to receive tax benefits, many banks are likely to use some of the benefit to offer customers lower interest rates on loans or perhaps reduce fees on banking products and services. In other words, they could cut prices for products and services, a deflationary consideration that we believe many economists have not considered as a potential result of the tax act. (Relatedly, we also have seen reports of some utilities stating they will use a portion of their tax cut to reduce customer electric rates.)

We believe that JP Morgan’s comments are instructive and likely to be similar to what other firms are thinking. For those looking for rising equity prices, this new tax plan sounds pretty good. Companies could share their tax savings with customers, employees, and shareholders, and also make further investments in technology, facilities, and personnel. If one believes, as we do, that many companies are likely to follow in the footsteps of JP Morgan, we can extrapolate across the US economy and imagine an environment where wages and benefits are moving higher, prices for certain goods and services will be reduced, and investments will be made that were not even on the drawing board a year ago. In addition, to the extent that heavily indebted firms now see improvements to their margins and cash flows, this tax cut could have positive impacts from a credit quality standpoint.

In addition to the direct impact of corporate tax cuts, it is also worth considering the direct impact of tax cuts for individuals, as well as the indirect impacts of tax cuts for both companies and individuals. Many people should see an increase in their after-tax pay due to pay raises and cuts in tax rates. At least some of this additional after-tax pay will likely be spent on goods and services, providing an additional benefit to economic growth beyond the direct impacts noted above. Together, these direct and indirect benefits could provide a meaningful boost to economic growth in 2018 and 2019.

In summary, together with the strong macroeconomic data we have recently seen and elevated consumer sentiment numbers, we think the already favorable fundamental outlook for equities is made even more so by what we see as the likely positive impacts of corporate tax cuts.

Double Whammy for Credit Markets in Fourth Quarter

Published on Jan. 18, 2018

Double Whammy for Credit Markets in Fourth Quarter

Market Overview

The Federal Reserve Open Market Committee (FOMC) maintained its slow and steady approach to normalize interest rate levels when it announced an increase to the federal funds target rate during its December 2017 meeting. This move marks the Fed’s third rate hike over the course of 2017, and expectations remain high for further rate hikes during 2018. Nevertheless, domestic interest rates remain stubbornly low by historical standards, namely those assigned to conservative vehicles such as bank savings offerings and US Treasury notes. While broad-based inflation statistics have also remained quite tame, economic barometers of general pricing pressure do not include the more volatile components of food and energy, nor do they reliably reflect monthly stresses faced by most individual savers and consumers to meet more basic needs such as rent, groceries, and tuition bills.

The extended hunt for yield that began after the financial crisis continues to exert extraordinary pressures on fixed income yields, pricings, and the interdependence between credit markets. Demand for investment grade assets to produce the highest possible current income has led to a persistent flattening of the US Treasury yield curve, while yield spreads between US Treasury and US corporate issues continue to tighten. Just two years ago, the US Treasury 2-year note traded at 1.05% yield to maturity, while the US Treasury 10-year note traded at 2.27% yield to maturity. At the conclusion of 2017, the same two issues were priced at 1.88% and 2.41%, respectively. While the Federal Reserve’s tightening monetary policies have effectively increased short-term interest rates, nearly doubling the market yield on the 2-year note, the 10-year note has barely budged.

Put another way, the US Treasury 2-10 year yield curve has flattened from 123 basis points (1.23%) at the end of 2015 to just 53 basis points (0.53%) at the end of 2017. For conservative income-oriented investors, the compression of yields available from investment grade corporate bonds over the same time has been even more pronounced. The 2-10 year yield curve of the domestic corporate bond market has collapsed to 113 basis points (1.13%) – nearly half of the 207 basis points (2.07%) steepness that existed along this yield curve two years ago – dramatically reducing the availability of potential current income levels. There are myriad explanations for such dramatic movements along these yield curves, but the bottom line effect is one and the same: investors have been steadily offered less income incentive to extend the maturities of their investments while simultaneously being left to assume more credit risk to obtain the same returns available to them two years prior.

The double whammy of a flattening US Treasury yield curve and a concurrent tightening of credit market yield spreads has not, however, been without recent benefits. Last year, despite the Federal Reserve Board’s monetary policy changes, domestic credit market indices produced significant total rate of return performances versus government-based indices. For instance, the ICE BofA Merrill Lynch 1-10 Year US Treasury Index produced a paltry 1.08% total return over 2017, while the ICE BofA Merrill Lynch 1-10 Year US Corporate Index produced 4.08% total return over the same period. As more risk was assumed, the rewards were further multiplied over Treasuries. The longer overall duration ICE BofAML US Corporate Index, which contains 1-30 year maturities, produced a 6.48% annual total return for 2017, while the ICE BofA Merrill Lynch Fixed Rate Preferred Securities Index returned 10.58% over the same period. As satisfying as this relative outperformance may have been for some investors, there may be a ceiling on the extent to which the same forces at play can influence further relative outperformance. With lessening yield curve protection and diminished credit spread advantages, there may be fewer opportunities for future relative return enhancements without assuming greater risk.


As previously noted, expectations remain high for further target rate increases during 2018, as well as the potential for more to follow in 2019. These rate hikes may work to alleviate some of the pressures for a more normalized rate environment that have been building among income-investors. In order to benefit from these potential changes on the horizon, fixed income portfolios will have to be allocated properly among various maturities to maximize the opportunities afforded by higher nominal interest rates, should they become available. As such, investing in short- to intermediate-term investment grade maturities may prove beneficial for income investors seeking consistent levels of annual cash flows and portfolio stability in rising rate environments.

Preservation of capital while maximizing current income remains a hallmark of prudent investment practices, and one of the governing tenets of the Roosevelt Current Income Portfolio Strategy. As pressures on fixed income investing have changed the market environment, innovations in the bond market are increasingly tailored to meet the demands of both lenders and borrowers to address the challenges of transitioning from a historically low interest rate environment to a potentially more normal landscape. One such development has been the growing issuance of fixed-to-floating rate preferred securities, which allow investors to earn initial fixed rate coupons for five to ten years while offering buyers the comfort thereafter that the issuer may either call the bond at par value or switch the coupon to a generous yield spread floating over money market rates. As highlighted last quarter, we believe that these securities offer a number of advantages, given the Current Income Portfolio’s fundamental objectives of current yield enhancement and principal safety. We continue to seek inclusion of these securities, as we deem appropriate, as well as other investment grade opportunities that may develop, in order to maximize income levels for our clients while preserving principal for future yield enhancement.

Stocks Move Higher to Close Out the Year

Published on Jan. 12, 2018

Stocks Move Higher to Close Out the Year

Market Overview

Stocks moved higher to close out the year, as the S&P 500 climbed 6.6% during the fourth quarter. Investor sentiment was boosted by economic data that continued to surpass expectations. Markets also reacted well to the passage of the GOP tax bill. We maintain our positive outlook as we continue to believe that healthy economic growth, strong corporate profits, and easing financial conditions should bode well for stocks moving forward.

For many investors, we believe that the tax bill was among the most eagerly anticipated policy initiatives of 2017, and that its progress and ultimate passage were likely key drivers helping to lift stocks during the fourth quarter. The tax bill also likely contributed to the sector rotation seen last month, during which cyclical and value stocks outperformed their growth stock peers. Details of the bill include a reduction in the corporate tax rate from 35% to 21%, lower individual rates, and the elimination of certain deductions in an effort to simplify the tax code. We believe that 2018 aggregate S&P earnings could see a boost of approximately $10 per share as a result of the lower corporate rate.

The extent to which passage of the GOP’s tax bill may boost the economy remains a topic of debate. Some critics of the bill point out that many corporations have effective tax rates that already approach the new statutory rate, and therefore they may not see a material boost to their net incomes. That said, in our view, smaller companies – many of which are domestically oriented and therefore typically pay higher tax rates – are likely to see greater benefits. Moreover, it is these smaller businesses which are typically the primary drivers of job growth. To the extent that these smaller businesses benefit from the new tax code, an already healthy labor market could get a further boost. Finally, we believe that small- and medium-sized businesses are likely to reinvest a significant amount of their tax savings, as opposed to increasing share buybacks or dividends. These investments have the potential to be another positive factor driving GDP growth in 2018.

The Federal Reserve will have a new chairman next month as Jerome Powell takes the helm from Janet Yellen. We expect that this will be a relatively smooth transition, as Powell has not dissented on any policy votes during his tenure as a member of the Federal Reserve Board of Governors, and his remarks have typically echoed the committee’s consensus view. In terms of any stock market impact, we view financial companies as potential beneficiaries, as we believe that Yellen is more hawkish with regards to banking regulations than Powell appears to be. In our view, should Powell relax banking industry regulations, it would likely enhance the sector’s earnings power.

The flattening yield curve has garnered a great deal of investor attention in recent months, with some wondering whether it is portending weaker economic conditions ahead. At this point, we are not overly concerned with this because, as we have noted in the past, it is not unusual for the curve to flatten while the Fed is raising rates. Moreover, we believe that very low government bond yields in other developed economies are also playing a role in depressing US yields. The flattening curve is more a reflection of divergent monetary policy and relative bond values in our opinion, as opposed to signaling an impending recession. However, we are keeping a close eye on this indicator. If the curve were to continue to flatten and ultimately invert, we would view this as a troubling sign and we would likely reassess our economic forecasts.


We continue to hold a constructive view on equities. Economic activity has picked up over the last few quarters, and more recent data has also been encouraging. Consumer confidence hit a cyclical high during the fourth quarter, and the labor market remains robust with both unemployment and job openings at multi-year bests. The ISM’s manufacturing sector index easily surpassed expectations for December, and its forward looking new orders sub index showed particular strength. Looking forward, we believe that consumption is poised to support future economic activity. With some tax relief on the horizon, in addition to minimum wage increases and many corporations having already announced special one-time bonuses, we anticipate strong consumer sentiment should continue to translate into healthy consumer spending.

International economic activity continues to firm coinciding with the domestic strength. This synchronized recovery, in addition to a US corporate sector which is generating strong profits, and financial conditions which remain quite accommodative, are the key underpinnings to our optimistic outlook.

There are, however, pockets of the US economy that we have concerns about. While the holiday season was a good one, we expect that mall-based retail will continue to weaken as more spending moves online. We also would not be surprised to see some reduced levels of activity in the housing and automotive industries, as they may have seen some unsustainable pent-up demand in the aftermath of last year’s severe hurricanes.

We are also keeping a close eye on currency markets, as we see several factors which could lift the dollar in 2018, potentially crimping corporate profits in the process. With the passage of the GOP’s tax bill, corporations may soon be repatriating large sums of money back to the US. Depending on the magnitude of these transfers, they may be sufficient to move the dollar higher, but we also see other factors such as Brexit and potential trade disputes which could magnify the effect. With valuations somewhat extended, earnings will likely have to meet expectations in order for stocks to continue to climb higher in 2018; a strong dollar would make this more difficult to achieve and we therefore consider this to be an important risk factor to monitor.

Many market strategists are calling for clients to increase their exposure to more cyclical holdings, based on the belief that strong economic momentum will enable these securities to outperform. While we share this optimistic view of the economy, we do have some concerns and believe that it is more prudent to take a diversified approach. We have therefore constructed our portfolio in a barbell fashion, whereby we are allocating material exposure to cyclical and value stocks, while also maintaining sizeable exposure to more defensive names that should help to protect the portfolio in the event of worsening economic conditions.