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Q4 2019 October 11

INVESTMENT OUTLOOK

DBFitzpatrick


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INVESTMENT OUTLOOK | Q4 2019

INSIDE THIS ISSUE:

Equities: Trade Negotiations the Story for Fourth Quarter

3—4

Fixed Income: Security Selection Key with Rate Outlook Murky

4—6

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


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EQUITIES: TRADE NEGOTIATIONS THE STORY FOR FOURTH QUARTER The broad equity market was flat in

The global economy is slowing. U.S.

usually a sign of considerable investor

the third quarter despite increasing

GDP growth has slipped to 2.3%,

pessimism regarding economic

signs of economic slowdown and

with growth in Europe and major

growth prospects in the near term.

continued investor unease regarding

emerging market economies China

The labor market continues to be a

the trade conflict between

and India also declining. Housing

bright spot in the U.S. economy, with

Washington and Beijing. Interest

price increases in the U.S. have

the unemployment rate at a historic

rates continued to fall during the

moderated considerably this year, with low of 3.7%. Many investors fear,

quarter and this, combined with the

the Case Shiller Home Price Index up however, that this figure is a lagging

optimism of many investors that a

just 2.0% year-over-year in July, its

trade deal will eventually be reached,

slowest pace in seven years and down growth. The bond market appears to

was enough to keep stock indices

from 6.3% a year earlier. In another

relatively unchanged.

sign of potential trouble ahead, recent year Treasury bonds falling from

indicator of the direction of economic share this view, with the yield on 10-

data show that the U.S. manufacturing 3.08% one year ago to 1.74% today. The MSCI All Country World Index

sector has slowed significantly and is

returned 0.1% during the third

currently contracting. Additionally,

quarter, while the S&P 500 was up

inflation breakeven rates in the U.S.

1.7%. Emerging market stocks,

(what investors expect inflation to be

which tend to be the most vulnerable

in the future) are down in the last six

to trade tensions, were down 4.2%

months, with the 2-year breakeven

during the third quarter as measured

rate at 1.26%. A figure this low is

by the MSCI

Economic data have led to a somewhat dour mood among investors in recent weeks, but it’s

important to keep in mind that resolution to trade tensions has the potential to dramatically change the

Emerging Market Index. Stocks are still up considerably this

S&P/Case-Shiller US National Home Price Index

year, with the MSCI All Country World Index and S&P 500 returning 16.7% and 20.6%, respectively, year-to-date through September.

Source: Bloomberg


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INVESTMENT OUTLOOK | Q4 2019

short-term outlook for equities. Most investors view the trade conflict between Washington and Beijing as significantly

ISM Manufacturing PMI

negative for stocks (we share this view), so a lasting

- A figure below 50 indicates contraction

resolution would likely buoy equity prices considerably in

Source: Bloomberg

the near term. A deal can’t be ruled out, as China’s

2-Year US Breakeven Inflation Rate

leadership keeps its

intentions well hidden and the political environment in the U.S. has entered a period of increased uncertainty. It’s likely the case, however, that with each passing week Source: Bloomberg

China’s leaders will see more

advantage in delaying serious discussions toward a long-term deal until after next

are likely to continue weighing on stocks.

year’s elections in the U.S. Consequently, trade tensions

FIXED INCOME: SECURITY SELECTION KEY WITH RATE OUTLOOK MURKY Interest rates fell again in the third

of September, as the trade conflict

for cuts have forced their hand. In

quarter, with the yield curve flattening remains unresolved and economic

spite of continued reluctance among

slightly after the Federal Reserve (Fed) growth has slowed. Federal Reserve

Fed policymakers to cut rates, the

lowered the fed funds rate in July and policymakers have been resistant to

bond market is hankering for – and

again in September. Interest rates

predicting – more cuts this year (bond

lower interest rates for most of this

have fallen significantly this year, with year, though consistently weaker eco-

investors see an 80% probability of at

the 10-year Treasury yield down from nomic data, falling inflation breakeven least one additional rate cut this year, 2.78% in January to 1.67% at the end

rates, and bond market expectations

and a 25% probability of two cuts).


5 We’re forecasting that the Fed will

third quarter and remain very tight by Agency mortgage-backed security op-

hold rates steady during the upcoming historical standards. We remain con-

tion-adjusted spreads have widened

October meeting, with a 25 basis

servative with our corporate bond

this year, concurrent with falling inter-

point cut occurring in December.

positioning, emphasizing highly rated

est rates. 3.5% coupon securities have

Such a course of action would be con- companies and very liquid securities.

seen the most spread widening, with

sistent with chair Jerome Powell’s bal- The yield advantage today of such

prepayment incentive increased signif-

anced management of FOMC opin-

corporates versus Treasury bonds is

icantly for their underlying mortgages.

ion.

only moderate, but exposure here of-

There has been notable spread widen-

fers us the possibility of easily reposi- ing with 3.0% coupon securities as The fed funds rate cut in September

tioning to lower rated corporates

well. Given the market dynamics of

lowered the very short end of the U.S. (though still investment grade), if and the previous months and the yields Treasury yield curve significantly, but

when credit spreads widen significant- available today, we see value in agency

steepening was limited by significant

ly. The credit cycle appears to be

declines in the 5-10 year area of the

quite extended, and we have prepared underlying servicer exposure, geo-

curve. We view this as evidence that

to take advantage of a change in mar- graphical breakdown of underlying

bond investors have become more

ket dynamics.

MBS with security selection (including

confident in their prediction of a recession occurring in the next

US Treasury Yield Curve

12-18 months. Corporate spreads remain tight, as investor pessimism regarding near-term economic growth prospects has not yet reached the credit markets. Spreads of lower rated investment-grade corporates were close to unchanged during the

Source: Bloomberg


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INVESTMENT OUTLOOK | Q4 2019

mortgages, and borrower credit risk) receiving close attention in our analysis.

BBB 1-5 Year Corporate Spreads

Given the uncertainty regard-

ing the direction of interest rates (the outcome of trade negotiations is uncertain, as is the severity of any coming

Source: Bloomberg

economic slowdown), we are maintaining the duration of our fixed income portfolios

close to their respective benchmarks. We see relative

Bloomberg Barclays US MBS Index Option -Adjusted Spread

value in agency MBS, while carefully controlling credit risk by holding only highly rated corporates and, in some cases, lowering corporate ex-

Source: Bloomberg

posure. With our MBS positioning, we are overweight conventionals though slightly up in coupon, resulting in

ter would not come as much surprise. We stand ready for

duration and convexity characteristics close to respective

such a scenario.

benchmarks. Given the dynamics today, increased volatility in the fixed income markets during the fourth quar-

— 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

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Investment Outlook Q4, 2019  

Investment Outlook Q4, 2019