Q2 2018 April 10
INVESTMENT OUTLOOK
DBFitzpatrick
REGISTERED INVESTMENT ADVISORS
INSIDE THIS ISSUE:
Trade Talk Driving Risk Assets
3-4
Fixed Income: Further Flattening Likely
4-6
DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 (208) 342-2280 www.dbfitzpatrick.com
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TRADE TALK DRIVING RISK ASSETS The stock market got off to a good weeks before regaining their
retracing some of their recent
start during the first weeks of
gains. The issue of trade conflict is
footing in early February. The
January (with the S&P 500 up over equity markets were then fairly
likely to remain relevant for the
7% at one point), but had choppy
calm until early March, when
stock market, however. The
results for the rest of the
president Trump began to insert
United States has not had a leader
quarter. Despite significant moves himself more forcefully in trade
as protectionist as president
along the way, the major indices
disputes between certain
Trump for several decades, and
exhibited relatively benign results
economic sectors in the U.S. and
trade is obviously an important
for the full first quarter, with the
those from various other
issue for him and segments of his
S&P 500 returning -0.8% and the
countries. Stocks fell as fears grew constituency. There are winners
MSCI All Country World Index
that all-out trade wars might
and losers from trade, of course,
returning -0.9%.
ensue.
but investors generally view trade as beneficial for the economy and
Interest rates had been climbing
We believe that the issue of rising
for the stock market. Consistent
since last September with equity
interest rates is likely to abate in
with this, stocks fell in March after
investors hardly seeming to notice the coming months, with inflation
the president began taking action
(all things equal, higher interest
breakeven rates (investors’
to affect trade deals.
rates are a negative for stocks as
expectations for future inflation)
cash flows from equities face a higher discount rate), but notice was finally taken when the yield of a 10-year Treasury bond reached 2.70% in January. Stocks buckled for two
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INVESTMENT OUTLOOK | Q2 2018
Most equity investors seem to believe that the president will eventually back off from his most fervent rhetoric on trade, and will declare victory after attaining modest concessions from trade partners. A significant risk,
appears close and falling when it seems far away.
however, is posed by the fact that the president uses trade deficit figures as the measuring stick of
Our equity portfolios are positioned defensively,
success and failure when addressing trade deals.
with the intention to rebalance into more cyclical
Trade deficits are determined by many factors,
sectors (industrials and materials, for example) if
including currency valuations, global capital flows,
the market pulls back significantly. We may get the
and fiscal deficits, and the president is not likely to
chance to make this move, as stock market indices
find it easy to lower them much with only modest
today are still trading at levels that are moderately
tariffs. What will the president ultimately see as
elevated by historical standards (the S&P 500
victory and what will he accept? This will be an
currently trades at 16.9 times expected 2018
important question in the coming months, with
earnings).
stocks benefitting when a declaration of ‘victory’
FIXED INCOME: FURTHER FLATTENING LIKELY Federal Reserve policymakers
was positive for our fixed income
raised the federal funds rate 25
portfolios as we incrementally
year.
basis points in March, but inflation extended duration in February to
Investors were optimistic about
breakeven rates fell during the
the economy’s prospects in the
take advantage of higher yields
month and this led to a flatter U.S. available in the market after
aftermath of the passage of the
Treasury yield curve. This dynamic Treasury prices fell earlier in the
‘Tax Cuts and Jobs Act’ late last
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year, but that optimism has turned into considerable
and growth expectations ratchet down.
angst as president Trump turned his attention to trade arrangements during the last several weeks.
Finally, it is important to mention the Libor - OIS
Fears of further escalation of trade rhetoric from
spread, which measures the difference between the
global leaders, combined with uncertainty regarding
U.S. dollar 3-month LIBOR rate (at which London
how this conflict will play out over the longer run,
banks lend to each other) and the 3-month U.S. dollar
have undoubtedly had an important impact on the
swap rate. The Libor - OIS spread has jumped in
fixed income market. Falling inflation breakeven
recent weeks, climbing to its highest level since 2009.
rates, higher corporate spreads, and lower yields on
Many analysts are blaming the rise on increased
the long end of the Treasury yield curve are all (at
issuance of short-term U.S. Treasury notes and the
least in part) a response to this increased worry.
repatriation of cash back to domestic banks in the
Corporate spreads rose in March, consistent with the increased volatility seen in the equity market. Even after this move, however, spreads are fairly tight, with room to widen further if investor worry continues to increase.
Meanwhile, Inflation breakeven rates, after rising
considerably from last summer to the end of February, fell in March. They are likely to fall further in the coming weeks if headlines remain fairly bleak
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INVESTMENT OUTLOOK | Q2 2018
aftermath of tax reform in the U.S. The possibility also exists, however, that the increased spread is indicative of stress beginning to form in the credit markets.
We are forecasting that the U.S. Treasury yield
curve will flatten further, with the short end of the curve rising as the Federal Reserve continues to raise the federal funds rate, and the long end declining modestly. Consistent with this view, within our fixed income strategies we are maintaining durations slightly longer than those of corresponding significantly from current levels. The road ahead benchmarks. Additionally, we are watching
may be bumpy, and if so there will likely be
corporate spreads closely and plan to increase our
opportunities to rebalance into corporate bonds.
exposure to corporate bonds (where permitted by
— Brandon Fitzpatrick
client mandate) if and when spreads widen
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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 D.B. FITZPATRICK & COMPANY 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. 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. ALL RETURNS ARE MODEL RETURNS FROM A COMPOSITE.
DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 www.dbfitzpatrick.com | (208) 342-2280