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Quarterly Investment Review

A message from the Investment Management Team of Strategic Advisers LLC

By Brian Enyeart, CFA®,* President, Strategic Advisers LLC

First Quarter 2019: Key Takeaways

  • GLOBAL STOCKS REBOUND
    Following a near 17%1 decline in late 2018, stocks rebounded strongly as the Federal Reserve signaled a pause for future interest rate hikes.
  • LATE CYCLE ECONOMIC EXPANSION
    The experiences over the last several months are typical of late cycle expansion, which is a period with slowing but positive economic growth, greater uncertainty, and higher market volatility.
  • CHINA SLOWDOWN AND POLICY MOVES
    In the midst of another economic slowdown, policy makers in the world’s second largest economy are seeking to stimulate growth that, if effective, could support international markets.

Stocks bounced back at the beginning of 2019

Stocks around the world rose strongly in the first quarter, led by the U.S. Overall, most accounts held modestly more U.S. stocks compared to their long-term asset allocation mix, which helped returns. Overseas, while economic growth slowed, developed and emerging market stocks rebounded. Meanwhile, bonds had a strong quarter with high yield bonds outpacing investment grade bonds.

U.S. economy is firmly in late cycle economic expansion

  • Despite higher market uncertainty, we anticipate slower, but still positive, economic growth.
  • Global corporate earnings growth should support stocks around the world.
  • We believe this could lead to a positive environment for investors in spite of periods of volatility.

Given the current market backdrop of low unemployment, rising wages, and a positive corporate earnings outlook, we rebalanced client accounts during the quarter. In most accounts, we sold stocks, which grew in value for much of the quarter, and bought bonds. This kind of activity can help keep client investments consistent with their goals.

Domestic stocks led market recovery

U.S. stocks rose 14%2 during the quarter, led by traditional growth areas of the market such as technology, which was the top performing sector. Many funds in your portfolio own slightly more growth and technology stocks than the market, which helped performance.

Stocks with more of a quality orientation also performed well. Compared to the broader market, quality stocks typically have:

  • more consistent earnings growth
  • higher return on equity
  • lower levels of debt

Historically, quality stocks have held up well in late cycle. Client accounts benefited from our positioning as we tilted toward quality stocks over the last year.

As for performance detractors, value stocks continued to lag growth. As a result, those investments slightly hurt performance. Furthermore, your investments had less exposure to defensive and income-oriented parts of the market. This hindered performance since these stocks had solid gains during the quarter.

International stocks rebound

Developed and emerging market stock returns also rebounded during the quarter. Similar to the U.S., areas of the market that were hurt late in 2018 performed best. In particular, China, technology, and growth-oriented investments, which are positioned to benefit from improvements in global growth, all did well. Within international stocks, we continued to favor quality and growth, which helped returns. During the quarter, we rebalanced by selling international stock funds when they performed well and buying bond funds instead.

Bonds had a strong quarter

U.S. Treasuries performed positively during the quarter, particularly in March. That’s when interest rates fell, as the Fed signaled a pause in future rate hikes, given slowing growth and low inflation. Outside of treasuries, as investors regained confidence in corporate earnings growth, worries about bond defaults receded. This helped investment grade bonds gain 2.9%3 and high yield bonds returned 7.4%4. Client accounts benefitted from these returns, given our modest allocation to high yield bonds and our higher allocation to corporate bonds versus the market. As the cycle matures, we believe that high yield bonds may experience more volatility. Therefore this quarter, we continued to reduce exposure to high yield in favor of investment grade bonds.

Strong performance for extended asset class driven by REITS

In the first quarter of 2019, the portfolio’s alternative investments had strong positive performance. Positions in both domestic and international real estate investments generated solid gains for the period. More specifically, domestic real estate investments benefitted from a continued robust economy. Commodities also posted positive returns over the first quarter, as growth showed signs of picking up in China, which is one of the world’s largest commodities consumers. Finally, certain multi-strategy funds that seek to identify and invest in market trends within global bonds and commodities had more challenged returns, due to volatility in these areas during the period. We maintain exposure to alternative investment strategies in your account based on their ability to help provide differentiated sources of returns during certain phases of the business cycle when compared to more traditional stock and bond funds

Chinese stimulus policies may boost the global economy

A key driver for continued global economic improvement relies on the effectiveness of Chinese policy moves. Today, China is in the midst of another slowdown, which has put downward pressure on industrial sectors of Europe and other export-oriented economies. Consistent with previous slowdowns, Chinese policy makers are seeking to stimulate growth through various mechanisms, including infrastructure spending, tax cuts, and lower interest rates. In addition, it appears that the U.S. and China are getting closer to resolving some of their trade issues. Should these measures feed into the global economy through increased imports, exports, and business activity, they may help support global economic growth.

Our view on U.S. interest rates

Some news outlets have reported that the U.S. economy may soon enter an economic recession due to recent trends in interest rates. In our view, these interest rate moves are merely a reflection of slower economic growth, rather than a reliable signal of what’s to come.

In fact, we see signs that the U.S. economy continues to grow. For example, employment remains healthy and wages are rising slowly. Consumers and businesses can also obtain loans for spending and investment, key drivers of economic growth.

As to the Fed, it has signaled a pause in future interest hikes. This reflects their view that the economy is growing slowly, and thus, inflation is not a significant concern.

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