Taking its cue from the previous three months, markets again proved to be increasingly volatile for investors over the course of the most recent quarter. Market returns were mixed over the entire three-month period but, in general, risk off assets outperformed. Most notable was the performance of US Treasury securities (the ultimate risk off asset). For the quarter, yields declined on 30-year Treasury bonds by roughly 40bps, closing the quarter at 2.1%. During August, the 30-year bond yield hit its all-time low of 1.95%, reflecting increasing concern over US – China trade negotiations and the potential for associated economic deterioration. As a result, total returns on long bonds for the quarter exceeded 8%! In fact, when we look across the investment spectrum at a series of higher risk/lower risk investable choices, in virtually every instance, lower risk proved to be the superior performing investment during the quarter.
In the recent period where economic data continues to decline at the margin and Trump-tweet induced volatility spikes can wreak havoc on your portfolio, investors have taken the clear choice to err on the side of caution and that decision is not entirely irrational. Our analysis of key economic and investment variables leaves us with the belief that the fundamentals look mixed, at best, thereby justifying investors risk aversion.
As has been understood for some time, the trade dispute between the United States and China sits at the middle of this increasing global economic uncertainty and weakness. To a certain extent, initiating a trade negotiation with China has been a worthy exercise. Currency manipulation, unfair trade practices and, most importantly, intellectual property rights are issues worth fighting over. Yet, we are at the point that the efficacy and approach to our negotiations needs to be questioned. Unlike previously advertised, trade deals may not be so easy to win. We have long believed that it is beneficial to both the US and China to strike a deal, but the timing and terms are entirely uncertain, particularly as both nations are dealing with domestic political issues which add to the complexity of the trade outcome. For the US and President Trump, the pending impeachment hearings will act as both a distraction and a reason for China to delay. Perhaps President Xi believes he can strike a better deal with a President Warren or a President Biden. However, China has its own problems and time is not necessarily on China’s side. Increasingly, China’s economy is weakening due to the US imposed tariffs and the Hong Kong protests are a meaningful indication of increasing political discourse in China. As a result, the global economy is slowing down and the longer the trade dispute goes on the larger the negative impact on the global economy and markets.
For investors not all is lost as financial conditions remain highly accommodative and global central banks have re-engaged in monetary easing policy. In fact, since May of this year, more than 25 interest rate cuts have been initiated by central banks to stimulate economic growth.
As active investors, Crow Point Partners attempts to be forward looking in our viewpoints and live by the convictions of our opinions by allocating capital to areas of the marketplace where we believe the best risk/reward opportunities lie. And the current environment has led to some meaningful performance and valuation discrepancies. Small cap stocks have underperformed large caps sharply and that divergence has created opportunities. Value equities relative to growth equities have reached historic valuation gaps.
And most importantly, bonds, particularly government bonds of all varieties, are very over valued and opportunities remain challenging for fixed income investors.
Yet, these economic and market conditions may persist for some time as investors wait for resolution on the outcome of the trade negotiations which currently appears to be uncertain in terms of both time and scope. Yet for investors our analysis leads us to believe that markets will act in a binary fashion once an outcome is reached. If a constructive trade resolution is reached, we believe markets will likely experience a dramatic rotation. Long term rates will rise, the dollar will weaken, and the underperforming components of the global equity markets will likely recover; notably international equities, small cap stocks and value stocks. To the extent, that the outcome of the trade negotiations is negative or if negotiations are inconclusive, investors can expect markets to keep their current course where risk off assets continue to outperform and investors will experience greater pockets of volatility. During September investors got a quick snapshot into how a rotation may take shape as a number of the above-mentioned investments rallied sharply, albeit for a short period of time.
In as much as we want to live by the courage of our convictions, we believe the current economic and investment backdrop is a murky one and further muddled by ongoing political angst in Washington D.C. Very recent economic numbers have cast doubt on the growth trajectory of the U.S. economic expansion which has been the primary engine of global economic growth. Sometimes the best offense is a good defense and therefore we believe that while we wait for greater clarity the best course of action for investors is to take a largely neutral stance in the trade off between risky and non-risky investments. We realize this may not prove exciting to our readers, but we would rather pare our exposure to binary outcomes thereby providing us the opportunity to further analyze the investment backdrop for signs of change, and ultimately action, once a resolution presents itself.
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ABOUT THE AUTHOR
David Cleary, CFA is a Partner and Chief Investment Officer at Crow Point Partners
He acts as lead portfolio manager on the Crow Point Portfolio Solutions and the Crow Point Global Tactical Allocation strategies. Previously he spent 23 years at Lazard Asset Management where he held a series of senior portfolio management roles over multi asset and global fixed income strategies. He additionally served as the firm’s global head of fixed income, a $26 billion platform. Prior to Lazard, Mr. Cleary worked at UBS and IBJ Schroder, mostly in fixed income asset management roles. Mr. Cleary began working in the asset management field in 1987 upon his graduation from Cornell University, with a BS in Business Management and Applied Economics. Mr. Cleary is a CFA charterholder.
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