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Third Quarter 2019 Client Newsletter

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As is so typically the case this time of year, we’re scratching our heads, wondering where the time went. In the ‘excitement and noise’ categories, 2019 has done little to disappoint; we’ve seen trade war escalations, geopolitical flashpoints, a red-hot US consumer, and of course, more political controversy than we would care to touch with the proverbial 10-foot pole.

In this quarter’s newsletter, we will be discussing the technical characteristics of the market over the past 3, 12, and 120 months. We’ll explore the impact of consumer and business sentiment on investment and consumption. And our Investment Strategist and Equity Research Analyst, Austin Harrison, will provide a review of the returns that domestic equity markets have historically provided.

For clients and friends that might not be as interested in consuming this entire newsletter (it’s long, I understand), I’d like to add the quick reassurance that we’re having a great year. Fortunately, this difficult period in the equity market has opened the door for opportunities in fixed income, precious metals, and cash equivalents. Exposure in these alternative asset classes has helped us dampen day-to-day volatility, prevent significant drawdowns, and continue our upward trajectory.

We look forward to continuing this strong momentum into year-end. If you have any questions about your holdings, our strategy, or the market, please let us know.

Happy upcoming holidays to all,


Market Review

If you actively monitored markets in the 3rd quarter of 2019 and were asked to describe the price-action, you might use words like volatile, frenetic, or maybe just downright crazy.  The daily standard deviation of the S&P 500 over those 90 days registered a higher-than-usual +/- 0.93%.  Yet through all the volatility, the market ended the quarter up a measly 0.18%.  

This concept of ‘going nowhere fast’ is not new; in fact, it’s the exact trait the markets have exhibited for the last 12 months. The chart below shows S&P 500 over the 12 months ended 9/30/2019. Over that period, the market has experienced: a 4th quarter melt-down, a 1st quarter snap-back, and a few trade-fueled panics. Yet for all the volatility and angst-provoking headlines, the market effectively went nowhere. 

Sideways markets typically occur when fundamental concerns about the health of the economy rise to the surface. Since the great financial crisis lows in 2009, the S&P 500 has experienced three of these such phases:


  • The 2011/2012 consolidation was centered around the potential collapse of the European Union. The 2013/2014 uptrend that followed was the product of aggressively accommodative global monetary policy and a resumption in earnings growth.
  • The 2015/2016 consolidation was a miniature industrial recession triggered by the precipitous drop in the price of oil. The following uptrend in 2017 was sparked by the promise of corporate tax reform and deregulation.
  • Finally, the consolidation over the past 19 months has been one plagued by fears of a protracted trade war, a global manufacturing recession, and at times, a perception of restrictive monetary policy. It’s too soon to pronounce how this consolidation phase will end. But the direction of global trade policy and the upcoming 2020 presidential election will undoubtedly be significant inputs.



When most people think about stocks, bonds, business investment, or even the purchase or sale of a family home, they first think of money. And while money is the fuel that propels a transaction or a market, neither would be initiated or maintained without confidence. Confidence comes in many forms: whether it’s confidence in an institution, the rules of the game, or simply that tomorrow will look something like today, they all must be present for us to take the next step.

In markets and the economy, we’re generally interested in the level of confidence of two specific groups: the consumer and the business leader. If the consumer isn’t purchasing goods and services, why should the business leader hire and invest? Conversely, if the business leader isn’t expanding their enterprise and hiring, how can the consumer spend? Typically, when one of these groups pull-back from their specified activities, the other is not far behind.



Outside of compound interest, the US Consumer might be the most powerful force on earth. A few different surveys measure the comfort and confidence of US consumers. Each measure has its own methodology, so conflicting data is frequent. 

The University of Michigan has monitored the sentiment of US consumers in its index since 1978. Their expectations index is presented below since 1985.

It’s tough to say that the consumer is thrilled by way of the University of Michigan methodology, but they are also far from the depressed levels seen from 2008-2011.

Bloomberg, which produces a weekly consumer comfort index, is presented next. And the new all-time high in their indicator is an unequivocally positive reading on the consumers' health.

Our final snapshot on the consumer (and our personal favorite) is the unemployment rate. All things equal, employed folks spend more. And the Bureau of Labor Statistics U3 Unemployment Rate happens to be about as low as it has ever been.

In our view, the consumer still has confidence in their ability to earn, which is translating to confidence in their ability to spend. As we approach the holiday season, maintaining favorable sentiment and employment readings will be critical to sustaining the current economic expansion.


Business Leaders

Much like consumer sentiment, business sentiment is measured by more organizations than we’ll cover in this brief newsletter. Each survey tracks a specific subset of business leaders. The first group we’ll highlight here are Chief Executive Officers, as measured by CEO Magazine.

In addition to the deterioration in the CEO Confidence Index displayed above, we’re also seeing more qualitative reports of degrading business sentiment. A gauge of CEO confidence distributed by The Conference Board posted a 10-year low in October. A direct quote from that report on read:

                  “Tariffs and trade issues, coupled with expectations of moderating global growth, are causing a heightened degree of uncertainty. As a result, more CEOs than last year say they have curtailed investment…”

    In past newsletters, we’ve highlighted the importance of US and Global Purchasing Manager Indexes (PMI). These indicators move down the corporate totem pole to the employees that manage hiring, orders, shipments, pricing, etc. A reading over 50 indicates economic expansion, while a reading below 50 denotes contraction. These surveys are divided into US Manufacturing and US Non-Manufacturing (services) sectors.

    PMIs in the United States are headed in the wrong direction. This negative trajectory fits with the narrative of slowing business fixed investment spending. When business leaders are less confident about their underlying companies’ growth, it’s natural that they would pull back on broad-based business investment. Unfortunately, that is precisely what we see in the data.



    As we’ve covered earlier in this newsletter, markets have effectively gone nowhere over the past 19 months. But does that indicate weak investor confidence? The price of the Dow or S&P on a given day is an excellent indication for how much it costs to buy the market, but it does a pretty lousy job of telling you the value of the underlying assets. 

    To gauge the value of what you’re buying, you need to equate that stock price to the earnings power, dividend, or otherwise productive capacity of the asset. Generally, this exercise is accomplished using what’s called the Price to Earnings (P/E) ratio. 

    The current P/E on the S&P 500 is 18 times 2019 earnings. And while 18x is not cheap, it’s also far from expensive relative to previous periods. As a gauge of confidence, the current valuation regime indicates that investors are securely in a ‘wait and see’ kind of mood. 

    Investor confidence is the ultimate combination of consumer and business confidence. Currently, consumers are still buying, and business leaders are just beginning to pause. Should business leaders begin to cut wages or hiring, watch out for a landslide in investor confidence.


    Long-Term Returns

    Since the inception of S&P 500 price data in 1928, stocks have delivered an outstanding annualized return of 10%. As investors, many of us have been conditioned to believe that a compound annual growth rate (CAGR) of 10% per year is not only possible, but a near-certain outcome if we just stick to the plan. It’s comforting to know things will always work themselves out if we give them enough time. The truth can be harder to swallow: 10% per year is not quite the same as 10% every year. Moreover, you won’t have the luxury of leaving your assets untouched for 90 years, and you probably won’t sit by and watch your retirement account get cut in half without taking action. In short, just playing the game doesn’t mean we’re entitled to double-digit returns over our investment horizon.

    Much like the last 10 years, the long-term history of the S&P 500 price index (below) has been marked by periods of uptrends and consolidations. Over the long term, market participants benefited from extended periods of outstanding growth, but sometimes invested for years without meaningful asset appreciation.

    True, dividends would add to the return during the stagnant periods shown above, and it’s not entirely fair to exclude them. Then again, it’s not entirely fair to exclude inflation either. Inflation doesn’t get much attention anymore, especially when talking about investment returns - for that we can thank the Fed and 25 years of core CPI readings below 3%. But since we’re analyzing 100 years of historical data, not just the last 25, we can’t afford to ignore it. So what happens if we included both dividends and inflation? We still see extended periods of time where stocks provide no meaningful appreciation in purchasing power. Each data point in the chart below represents the annualized total return for the S&P 500 over the preceding 20 years. (The underlying equity and inflation data go all the way back to 1871, courtesy of Robert Shiller’s online database.) 

    No less than 4 times in the past century, equities provided less than 1% in real return per year for a 20-year period. For plenty of savers, 20 years is longer than their investing life! And though the annualized real return over the entire dataset is a respectable 6.9%, the 3.6% average achieved over the most recent 20-year period should remind us just how volatile returns can be. Mr. Market doesn’t care about our retirement plans. He doesn’t owe us anything. To be sure, stocks have been one of the best long-term wealth generators, but investment returns are cyclical. They can come in bunches or not at all.