Investment Outlook Q1 2020

Q1 2020 January 14

INVESTMENT OUTLOOK

DBFitzpatrick

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INVESTMENT OUTLOOK | Q1 2020

INSIDE THIS ISSUE:

Yield Curve Steepens as Fed’s Dovish Turn Is Complete

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Equity Market Buoyant, though 2020 Outlook Cloudy

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DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 (208) 342-2280 www.dbfitzpatrick.com

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YIELD CURVE STEEPENS AS FED’S DOVISH TURN IS COMPLETE Interest rates declined meaningfully in Policymakers will likely not raise rates off on further moves with interest 2019 as economic growth slowed and unless inflation is persistent and

rates for the foreseeable future, and

the Federal Reserve (Fed) embraced a exceeds their mandated target of 2.0% will instead direct their focus in 2020 dovish monetary policy. The term

(today the 3-year inflation breakeven

to the Fed’s balance sheet. Balance

structure of interest rates steepened

rate is just 1.54%). At the same time,

sheet expansion is likely to continue

during the second half of the year as

given the three rate cuts made in

until a long-term solution is found

the Fed became increasingly

2019, policymakers will also be hard-

regarding continued tension in the

accommodative.

pressed to cut rates further in the near short-term debt market. term unless the risk of a recession

Despite policymakers showing

increases materially (investors are

Positive investor sentiment and

resistance to cutting rates early in

currently forecasting no interest rate

demand for yield caused corporate

2019, the Fed ultimately cut rates

changes during the first half of 2020,

spreads to tighten 60 basis points in

three times during the year.

with one 25 basis point cut in the

2019, nearing their tightest levels since

Additionally, the Fed has expanded its second half of the year). We believe it the financial crisis. We expect credit balance sheet significantly in recent

most likely that policymakers will hold spreads to widen in the coming

months. Since September, the Fed has been purchasing up to $60 billion in short-

U.S. Treasury Yield Curve

term Treasury bills monthly with the goal of strengthening bank reserves and improving liquidity in the short-term debt market.

After moving from a hawkish tone to a dovish one during the last 12 months, it is unlikely the Fed will make significant policy rate adjustments in 2020.

Source: Bloomberg

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INVESTMENT OUTLOOK | Q1 2020

months due to declining earnings growth and the

growth in 2020. With these forces pressuring interest

resulting weakening of corporate balance sheets.

rates in opposite directions, we have positioned our fixed

Consequently, today we are conservative with our

income portfolios’ duration and convexity attributes to be

corporate bond positioning, emphasizing highly rated

closely aligned to their benchmarks. We are retaining

companies and liquid securities. Mortgage-backed

flexibility to adjust sector and coupon exposure, should

security spreads widened 4 basis points in 2019 due to

market conditions change.

heightened prepayment risk and interest rate volatility,

— Justin Packard, CFA

and today offer good relative value versus corporate bonds.

The combination of accommodative monetary policy and

3-Year U.S. Inflation Breakeven Rate

slower economic growth will likely keep interest rates range-bound in the coming months. A

continued dovish Fed is likely to cause the

Source: Bloomberg

dollar to depreciate, resulting in higher commodity prices and inflation breakeven rates.

Meanwhile, weakness in the manufacturing

Fed Funds Target Rate

sector and a potential slowdown in the housing sector are set to pressure economic

Source: Bloomberg

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EQUITY MARKET BUOYANT, BUT 2020 OUTLOOK CLOUDY The equity market had a very strong

nology Index up 46.6%. The energy

Headlines regarding trade negotiations

year in 2019, fueled principally by

sector was the worst performer, with

between Washington and Beijing in

lower interest rates but also by a grad- the Dow Jones U.S. Energy Sector

2019 were often jarring, but investors

ual de-escalation of trade tensions be- Index up 10.0%.

early on priced in an eventual diminu-

tween the U.S. and China. The MSCI

tion of conflict, thereby aiding equity

All Country World Index, which

The yield of a 10-year Treasury bond

returns. This forecast has been vindi-

measures the global stock market, re-

fell from 2.68% at the start of 2019 to cated, as political leaders are currently

turned 27.3% during the year. The

1.92% at year-end (having reached

wrapping up “phase one� (involving

S&P 500 Index (made up of U.S.-

1.46% in September). This was an

increased agricultural purchases from

based large cap companies) returned

important element of the story for

China and lower tariffs in the U.S.) of

31.5%, while the MSCI EAFE

equities, as lower interest rates tend to a potentially more comprehensive

(international developed stocks) and

encourage the movement of money

MSCI Emerging Market indices re-

into more risky sectors such as corpo- campaign in the U.S. about to heat up

agreement. With the presidential

turned 22.8% and 18.6%, respectively. rate bonds, real estate, and, of course, considerably, most investors believe Among sectors of the stock market,

stocks. This occurred last year, with

that further serious trade negotiations

technology was the top performer last equity valuations expanding.

between the U.S. and China will be

year with the Dow Jones U.S. Tech-

delayed until 2021. This potential de-

2019 Equity Returns

Source: Bloomberg

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INVESTMENT OUTLOOK | Q1 2020

lay should be a positive factor for equities as the next round of negotiations will address more sticky subjects such as currency valuations, technology transfer, and government in-

S&P Case-Shiller U.S. National Home Price Index

volvement in private industry.

Source: Bloomberg Looking forward to 2020, the outlook for equities is cloudy.

The housing and manufacturing sectors in the U.S. are showing signs of cooling off, while the U.S. GDP growth rate, though still respectable at 2.1%, has declined. A recession does not seem likely in the near term, but further econom-

U.S. GDP Growth Rate Source: Bloomberg

ic slowdown may be forthcoming. On the positive side for equities, trade tensions have With this analysis as a backdrop, we have positioned our abated considerably and the Federal Reserve has signaled equity portfolios somewhat defensively, with an overthat it will remain accommodative with monetary policy

weight position to healthcare stocks and an underweight

in the coming quarters. Both of these factors are likely

position to technology. We are maintaining flexibility to

already priced in to equity valuations, however, with the

rebalance into more cyclical sectors should the bull mar-

S&P 500 trading at 18.7x expected earnings. A rise of

ket falter.

long-term Treasury bond yields, even a modest rise of 50 - 75 basis points, would likely pressure equities.

— Brandon Fitzpatrick, CFA

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THIS PUBLICATION IS FOR INFORMATIONAL PURPOSES ONLY. THIS PUBLICATION IS IN NO WAY A SOLICITATION OR OFFER TO SELL SECURITIES OR INVESTMENT ADVISORY SERVICES, EXCEPT WHERE APPLICABLE, IN STATES WHERE DB FITZPATRICK IS REGISTERED OR WHERE AN EXEMPTION OR EXCLUSION FROM SUCH REGISTRATION EXISTS. INFORMATION THROUGHOUT THIS PUBLICATION, WHETHER STOCK QUOTES, CHARTS, ARTICLES, OR ANY OTHER STATEMENT OR STATEMENTS REGARDING MARKET OR OTHER FINANCIAL INFORMATION, IS OBTAINED FROM SOURCES WHICH WE AND OUR SUPPLIERS BELIEVE RELIABLE, BUT WE DO NOT WARRANT OR GUARANTEE THE TIMELINESS OR ACCURACY OF THIS INFORMATION. BLOOMBERG FINANCE L.P. IS THE SOURCE UTILIZED FOR GRAPHS THROUGHOUT THIS PUBLICATION. THE GRAPHS ARE USED WITH PERMISSION OF BLOOMBERG FINANCE L.P. NEITHER WE NOR OUR INFORMATION PROVIDERS SHALL BE LIABLE FOR ANY ERRORS OR INACCURACIES, REGARDLESS OF CAUSE, OR THE LACK OF TIMELINESS OF, OR FOR ANY DELAY OR INTERRUPTION IN THE TRANSMISSION THEREOF TO THE USER. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS PUBLICATION. NOTHING IN THIS PUBLICATION SHOULD BE INTERPRETED TO STATE OR IMPLY THAT PAST RESULTS ARE AN INDICATION OF FUTURE PERFORMANCE.

DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 www.dbfitzpatrick.com | (208) 342-2280