Talbot Financial – 2Q 2019 Review

Written by Jim Pirak on 04 August 2019. Posted in Blog

The stock market extended its rally during the second quarter as tariff fears eased and the U.S. Federal Reserve (“Fed”) signaled a willingness to cut interest rates. For the quarter, the S&P 500 Total Return Index (“Index”) returned 4.3%. Year-to-date through June 30, 2019, the Index returned 18.5%.

Second quarter investment returns were led by the Financials and Technology sectors. Talbot Financial client portfolios were overweight both industry sectors relative to our benchmark Index. In the Financial sector, we particularly favor the strength of certain banks’ balance sheets and the material amount of capital these banks are returning to shareholders through dividends and share repurchases. In the Technology sector, our view remains that we are in the early innings of long-term secular technology advancement propelled by cloud-based computing.

Conversely, Energy and Healthcare were two underperforming industry sectors during the second quarter. We remain underweight the energy sector given our concerns related to the longer-term supply/demand imbalance issues for fossil fuels. We are also underweight the Healthcare sector given regulatory and stock valuation considerations. However, we do like specific healthcare stocks and have opportunistically increased our percentage weight in the sector.

On a macro-level, the U.S. economic expansion that began in July 2009 is now 120-months in length. This represents the longest post-World War II expansion on record. With the length of the expansion in mind, we have contemplated the potential drivers for decelerating growth rates. Our primary concern is the threat of a recession, raising the questions:

The expansion period has been so long, is a recession imminent?
Will a trade war push the economy into a recession?
Will interest rates and monetary policy drive the economy into a recession?

First, the expansion period has been long; however, at just over a 2% annual growth rate it has been slow by historical standards. Hence, the U.S. economy is not “overheated” as it was preceding most prior recessionary periods. Furthermore, recessions are led by a series of leading economic indicators. We continually monitor these indicators, including job creation, credit performance, manufacturing data, interest rates and housing. Currently, none of these leading indicators are signaling a recession on the horizon.

Second, our view is the existing trade war environment will not push the economy into a recession. The imposed tariffs on $250 billion of Chinese imports and the ongoing threat of tariffs on an additional $300 billion will likely stir volatility in the financial markets and remain in the news media headlines. However, we view the threat of shorter-term issues manifesting into an unfavorable longer-term economic impact on the U.S. economy as low.

To substantiate our perspective, consider in 2018 the U.S. imported approximately $3.1 trillion of goods and services and exported approximately $2.5 trillion of goods and services. The difference between the two, roughly $600 billion, represents the U.S.’s trade deficit with the rest of the world. Fully 70% of this trade deficit, or $420 billion, is associated with China.

To provide some context, the total amount of goods and services the U.S. exports to China, $120 billion, represents 0.6% of U.S. Gross Domestic Product (GDP). Conversely, the total amount of goods and services China exports to the U.S., $540 billion, represents 4.4% of China’s GDP. We recognize that tariffs will have ramifications for small pockets of the U.S. economy, but overall we do not believe it will push the entire U.S. economy into a recession.

Finally, the Fed’s current monetary policy and its indicative stance on interest rates are supportive of continued U.S. economic growth. One of the Fed’s primary objectives is to control inflation. The Fed can influence the rate of inflation through its management of short-term interest rates. In 2017 and 2018, the Fed raised short-term rates to stay ahead of a potential increase in the rate of inflation. Since December of 2018, the last rate increase, data has illustrated that inflation remains at longer-term target levels. Recent commentary by the Fed suggests an easing stance toward short-term rates, meaning a potential reduction in rates. Such a move tends to stimulate, not stagnate, economic growth.

In summary, the outlook for U.S. economic growth remains solid and preliminary signs of a recession are scarce. Most importantly, the prospects for continued growth in the companies we own in our investment portfolios remains positive.

Please find attached your second quarter 2019 portfolio review to supplement the monthly accounts statements available through Schwab. The report provides a performance summary of your portfolio compared to our benchmark S&P 500 Total Return Index and lists the portfolio holdings by industry sector.

As always, we welcome the opportunity to review your portfolio in detail. Please do not hesitate to contact us with any questions.

Talbot Financial, LLC