Broker Check

2019 Q3 Letter to Clients

October 24, 2019

Dear Clients,

Summer has slipped away, and cool weather is becoming the norm. There is much to look forward to as the season brings us baseball playoffs, football, hockey, fall reading accompanied by pumpkin flavored treats, harvest fairs, Halloween and Thanksgiving.

We are very excited to announce the merger of Ponder Financial Group into SVWA. Scott Ponder brings a wealth of experience in both financial planning and investment management. We are happy to report that all the clients of Ponder Financial have transitioned to SVWA as well. We welcome all of you with open arms and the promise that you will feel even better served by the team at SVWA.

We are pleased to present you with your third quarter reports and commentary below.

Q3 in Review

Trade headlines have driven price action during much of the year with September and Q3 being no exception. A shift in the Fed's stance and a reduction in trade tensions sparked a rally that took the S&P 500 Index to a new high in July (S&P 500 data—St. Louis Federal Reserve).

Despite a late July rate cut, an escalation in trade tensions in August created a brief bout of volatility. Yet, the peak-to-trough decline in the S&P 500 Index amounted to just 6.1%.

Economic growth and a Fed that was (and probably still is) in rate-cut mode (the Fed snipped another quarter-point from the fed funds rate in September) cushioned the downside.

But a renewal of trade negotiations—more headlines—and a de-escalation of tensions were well-received by investors. When September ended, the S&P 500 was not far from a new high. (See Table 2 below.)

Enter Q4

While we suspect that trade headlines will continue to influence short-term trading, let us keep in mind that the uncertainty surrounding Brexit could also influence daily activity.

Meanwhile, Europe appears to be on the cusp of a recession. And if that is not enough, the speaker of the House launched an impeachment inquiry against the President.

Some of us are old enough to remember that President Nixon's troubles coincided with a nasty bear market. Was there a link between Nixon and the 1973-74 slide, which lopped nearly 50% off the S&P 500? Or did the economic fundamentals hobble the major averages? (See Table 1.)

Though political uncertainty likely exacerbated the sell-off in 1973, high inflation, high interest rates, and a deep recession took a big toll on stocks. Contrast 1973-74 with the late-1998 impeachment proceedings against Bill Clinton. Twenty-five years later, stocks performed well amid much better economic fundamentals. While no two situations are exactly alike, economic conditions today are more reminiscent of the late 1990s than Nixon's second term.

In our last quarterly letter, we introduced you to the charts provided by (See Graph 1).

The BaR Analysis Grid© (BaR = Baseline and Rate of Change) shown in Graph 1 clarifies current economic conditions and signals how near the economy is to a recession. The Mean of Coordinates (MoC) is the average of all plotted points on the graph and indicates the overall health of the economy. Leading indicators (LD) are a unique subset that apply strictly to the BaR, providing insight into emerging trends. The chart from EconPi shows that we are in the decline quad rather than the expansion quad which coincides with slowing growth.

The data seems to dovetail with Chairman Powell's comments on October 8th at the annual meeting of the National Association of Business Economics in Denver. He commented that there are no overheated or booming sectors in the economy and yet all sectors are expanding nicely. In short no boom means no bust. He said after two rate cuts the U.S. economy "may just be gathering itself, there is no reason why the expansion can't continue." There are however persistent concerns of slowing of capital expenditures, trade war issues, and contraction in manufacturing.

Global Outlook

Since the Financial Crisis in 2007 the Central banks around the world lowered interest rates and printed massive amounts of money as a form of stimulus to get the world out of the crisis. While this had a positive impact, now all those economies have become addicted to this stimulus. Every time that Central Banks attempt to rein in the stimulus measures, the economies start backsliding.

Since financing costs had been so astonishingly muted, corporations borrowed as much as they could and now the corporate debt level is 2-3 times what it was in 2007. Global sovereign debt is at record levels as well, and this is part of the reason global economies are slowing.

Much of the money that was created was used to expand businesses and build factories, which was great while growth was good. Now that growth is slowing there is over capacity in many areas. For example, Japan's factory orders are down -35% YoY, and China is seeing much of the same. When China slows, Europe slows. In the US, nearly half of S&P 500 companies' earnings are from foreign sales, so these are slowing as well.

The current global economic cycle peaked in late 2017 and continues to slow. Eurozone investor confidence fell -16.8 and is at 2012 levels, German factory orders -6.7% YoY, Irish industrial production -6.3% YoY, UK retail store sales -1.74% YoY, Taiwan exports -4.6% YoY, Mexico Business investment -7.6% YoY. These data all represent multi-year cycle lows and serve as a rhetorical contextualization of the prevailing state of global cyclical conditions.

Portfolio Positioning

This quarter, we are expecting US corporations to report Q3 earnings with softening growth rates YoY from the peak. This will most likely cause a spike in volatility in the stock market, and echo what we saw in Q4 2018. The good news is that since most foreign markets have been declining over the past 18 months, foreign investment funds have been coming to the US markets looking for positive returns and should continue to support our markets. In addition, the Federal Reserve does not like markets to decline, especially right before an election year, and will likely step in and lower rates if needed. The Fed may start another quantitative easing program to keep the economy going. These measures should keep us going through the next few quarters, up through the election.

Our defensive positions in assets such as Utilities, Real Estate, Bonds, and Gold have performed well since the peak of the US cycle in Q3 2018 as shown in Graph 2. We will continue to hold these positions as the earnings season progresses this quarter. If we get the correction that we expect, it may be a good time to add to growth assets again. However, if the global picture degrades any faster, it may be prudent to maintain our defensive posture a little longer.

Bottom line

We can point to uncertainty lurking in the near term but risks never completely abate. If they do, stocks are usually bid up to reflect perfection. It will not be long before disappointment sets in.

So, let us end on an upbeat note!

While we have seen a few rocky days this year, major indices have performed well, and the S&P 500 and the Dow have yet to shed 10 percent—an official correction. For the long-term investor, it has not been a volatile year because interest rates provide little competition for stocks, the consumer has been strong, and the economy is expanding at a modest pace.

That said, successful long-term investors do not make investment decisions based on an emotional response to daily volatility and are wary of being whipsawed by headlines.

Personal Notes @ SVWA

Tracy and Roberta: Tracy's brother got married in grand style on the shores of Lake Tahoe. It was special to share in their joy surrounded by family and friends.

Chris and Laura: Chris capitulated after years of harassment and begging on the part of his children and got a family dog. This summer we welcomed Lulu into the family, along with her soulful eyes, tiny bladder, insatiable curiosity, and infinite puppy energy. Wish us luck!

Scott Ponder and Erin: Scott and Erin live in Half Moon Bay and enjoy the laid-back atmosphere which includes occasionally bringing the dogs to work. They have been very busy with the process of moving clients over to SVWA.

Scott Yang and Denise: Scott is looking forward to the fall season, with the Golden State Warriors entering the new Chase center, and is hoping the Niners make the playoffs this year. Daughter Katelyn is trying to get her driver's license and is close to getting the coveted DMV appointment which is in low supply. Scott is going to the Chicago NAPFA conference early October and will learn and share the latest financial planning updates.

Monique and Family were able to enjoy many Oakland A's games over the summer, attending Root Beer Float Sunday and other family filled activities at the park. It was fun watching our first baseman, a local named Mark Canha (Go Bells!) sliding in with a wildcard as they did last year, Go A's!

Danielle has had a busy fall keeping up with work and her little one. She also recently served as a judge at a tea competition, where she cupped over 125 teas. She is sharing some of the entries with everyone in the office.

Jared is keeping busy, continuing as an intern 12 hours a week at SVWA, holding down a full workload at SJSU, and trying to have a social life on campus.

As always, we appreciate your confidence and welcome your questions.

Gratefully yours,

The Silicon Valley Wealth Advisors Team

Tracy Lasecke, CFP®Chris Duke, CFP®Scott Yang, CPA, CFP®Scott Ponder, CFP®
Danielle HochstetterMonique RuizJared Bollier


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