Thoughts on the Current Outlook - updated November 1

Long periods of low volatility are often followed by short periods of very high volatility.  Unfortunately, we never know when those spikes in volatility will occur – we just have to expect that they will inevitably happen.  And, they are pretty normal at least once or twice a year. 

October was one of those periods.  So far, it seems quite similar to the experience we had in late January and February of this year.  Remember?  It is easy to forget once the market bounces back like it did from March through September.   

You can find lots of pundits trying to explain what caused this pullback.  As usual, it is likely a combination of factors – rising interest rates, China trade concerns, mid-term elections, late economic cycle - with no one really sure what kicked it off. 

We believe that what we do have to be concerned about is the economic cycle.  US growth is now solidly above our long-term growth capacity, the Fed is well into a rate increase phase, credit spreads are near historically low levels and the US stock market has hit all-time highs.  These are all classic signs that we need to be on watch for recession.

Over the next year, we think the US economy will slow back down toward its expected long-term growth rate of 1.5-2%.  The question will become whether the Fed can assist with a “soft landing” or whether we get back to that growth rate via recession (negative growth for two or more quarters in a row). 

Either way, we think slower growth is ahead.  We are beginning to express this view via a gradual addition of high quality, longer term bonds to client portfolios and a reduction in high yield bond investments.  In addition, we are holding more cash than normal in our Essential Growth Portfolio strategy.  Finally, we have used the October pullback to harvest tax losses in certain international stock and fixed income investments.

Stock markets have rallied strongly the last three days.  This may mark the beginning of a return to all-time highs for US stocks.  But we remain cautious about the staying power of these gains.