Third Quarter Key Takeaways
The third quarter of 2019 was a choppy one for financial markets as investors continued to weigh the overall health of the global economy against a host of uncertain macro factors. Uncertainties included the ongoing trade war with China, a drone attack on Saudi Arabia’s oil fields, the seemingly never-ending Brexit negotiations, and—as September wrapped—an official presidential impeachment investigation in Washington, D.C.
On the economic front, the Federal Reserve followed its 25-basis-point interest rate cut in late July with another 25-basis-point cut in mid-September. This was in response to the weak global economic environment and the impact of trade policy on U.S. business sentiment and capital expenditure. The European Central Bank also cut its policy rate and announced it would launch a new open-ended asset purchase plan (i.e., quantitative easing) starting in November.
Amid this backdrop, equity markets rose in July, fell in August, then rallied in September. Large-cap U.S. stocks gained 2% for the quarter and have netted over 20% year to date. Smaller-cap U.S. stocks suffered more acutely during the market drops and ended the quarter down 2.3%. For the year to date, they are still up a healthy 14.1%.
Despite a rebound in September, foreign stocks posted negative returns for the quarter. Developed international stocks fell 0.9%, European stocks fell 1.8%, and emerging-market (EM) stocks fell 4.1%. The U.S. dollar appreciated 2% to 4% versus other currencies during the quarter, which was an equivalent drag on foreign stock market returns for dollar-based investors.
Bond yields around the world continued to move lower in the third quarter as deflation concerns took hold. The benchmark 10-year Treasury yield dropped to below 1.5% in early September as trade war and recession fears crescendoed. It then sharply reversed, then dropped back, ending the quarter at 1.68%, down from a 2% yield at the end of the second quarter.
U.S. core investment-grade bonds were flat in July, rallied sharply in August, then dropped in September as interest rates rebounded from historic lows. For the full quarter, core bonds gained 2.4%.
Corporate bonds gained for the quarter. Floating-rate loans returned 1.0% and high-yield bonds gained 1.2%. Core municipal bond funds were up a little over 1%.
The economic environment continues to feel like a game of tug of war between the contractionary effects from U.S. trade policy and accommodative/expansionary global monetary policy. The divergent outcomes we see as possible from here (recession vs. cyclical rebound) explain our balanced portfolio approach and focus on diversification. The upgraded quality of our fixed-income holdings should better protect portfolios in a recessionary event. Meanwhile, our international exposure on the equity side should benefit portfolios if a cyclical rebound takes hold. Together with the broader diversification across asset classes and investment strategies, client portfolios should be resilient across a range of economic and market scenarios.
The current investing environment and its range of conflicting outcomes only highlights why we believe it is important to incorporate a wide range of scenarios in our portfolio management process. The most effective way to do this is through diversification across multiple asset classes and investment strategies that have different risk exposures and different sources of return. Of course, this also means that not every position will perform well in every scenario or macroeconomic environment. That’s the definition of portfolio diversification and the essence of risk management under uncertainty.
We appreciate your trust in us and welcome any questions you may have.
—OJM Group Investment Team (10/7/19)