Three Key Thoughts:

1. The Gloom Has Lifted for Now

2. Falling Long Term Interest Rates: Good or Bad?

3. China and Europe: Moving in Opposite Directions

The Gloom Has Lifted for Now

A bit more than three months ago, the markets were obsessed with the possibility of a global recession. The US had reported some slightly weaker numbers, while Europe and China were definitely slowing. Combined with open-ended trade disputes with China, a potential Brexit mess, falling oil prices, a government shutdown and the Federal Reserve continuing to hike interest rates, the outlook was gloomy.

Now, it seems that all the gloom is forgotten, as stock markets have recovered most, if not all, of their losses from the fourth quarter of last year. But how much has really changed? The US economy is likely slowing from last year’s pace, Europe and China are slowing (although each has announced some modest stimulus plans) and Brexit is a mess growing by the day.

The biggest change is that the Federal Reserve has abruptly changed plans, effectively putting off any interest rate increases for the remainder of this year. Some pundits even expect the Fed to cut rates, should US economic data weaken any further.

Looking out over the next 18 months, the 2020 election will come into increasingly sharp focus, with the posturing by both sides eventually reaching a fever pitch. More importantly, little will get done as compromise has become a four letter word in Washington. That said, it is usually a good thing for the markets when nothing is getting done in DC.

Falling Long Term Interest Rates: Good or Bad?

We believe long term interest rates are an excellent barometer for the future health of the economy. The rate on the US Treasury 10 year bond has fallen from 3.3% in October to about 2.5% now. While you can argue that the fall in interest rates will stimulate some parts of the economy like housing, you can also argue that it is foreshadowing that growth will not be strong enough to generate much inflation. Our best guess is that we have slower growth but no recession in the near term.

If the Fed stays on hold, we could very well stay in this “Goldilocks” environment where economic growth is consistent – not too weak or strong – and inflation is low – but not too low. This would likely allow corporate earnings to grow at a reasonable rate and stock markets to continue to prosper. In this type of environment, our focus on individual stock selection should be helpful, as we concentrate on those companies which can deliver good results despite a more challenging “macro” outlook.

China and Europe: Moving in Opposite Directions

Outside the US, the Brexit battles have laid bare the fragilities of the Eurozone structure. We believe that part of the world will stay weak for the foreseeable future. That doesn’t mean there aren’t interesting investment opportunities – it just means the environment will be a headwind rather than a tailwind.

In China, the stock market has rallied very strongly so far this year on the back of government stimulus plans and hope of a comprehensive trade deal with the US. The outcome of the trade negotiations is very difficult to predict as the Trump administration has been inconsistent in its trade negotiations with other partners. That said, we believe the President really wants to complete a deal this year, so it can be used in his re-election campaign. And, we believe that President Xi also wants to do a deal so he can reinvigorate the mood of the Chinese people, which will help his stimulus plans. But each side wants a “win,” so a substantive deal is not assured until the negotiations are over.

Investment Approach

From an investment perspective, we have largely held asset allocation steady, with a modest overweight to US large cap and a substantial – but less than market – weight in international stocks. We remain underweight in fixed income, with an offsetting overweight in hedged equity strategies.