2018 Late Summer Market Commentary
How time flies! The third quarter of 2018 is underway, summer is headed to fall and school is starting in many parts of the county. It has been an interesting summer in the stock and bond markets with several different factors trying to pull the markets in opposite directions.
On the bullish side, we continue to see a backdrop of strong corporate earnings and steady growth in the U.S. On the bearish side, we have rising short end U.S. rates, the possibility of a global trade war, increased concerns regarding European fragmentation and currency and debt issues in Turkey. All of these issues create uncertainty in the markets and inside the minds of investors, which will almost always create a drag on global equity market returns.
Summer is traditionally a period of a low volume in the number of shares traded. We expect September and October will bring the return of market volatility as institutional portfolio managers and traders return to work after the August break. While volatility creates uncertainty in an investor’s psyche it also represents a great time for advisors and investors to buy quality holdings at cheaper prices.
At Copper River Advisors we scaled back our global equitie exposure in nearly every portfolio over the past 6 months. In 2018 Emerging Markets are down 6% year to date and developed markets outside the U.S are in negative territory as well.
In general, we still believe that diversified exposure to U.S. equities in the next two quarters will bode well for investors. Our sector rotation strategy has proven effective during 2018. Our preferred sectors continue to remain as strong anchor positions and include North America Technology, Aerospace and Defense, Small Caps (Russell 2000) and Basic Materials.
With the possibility of an expanding U.S and global slowdown on the horizon we will be considering an overweight to health care, REITs and possibly utilities (which has been a lagging sector over the past few years). As a firm, we have been buyers of the “FANG” sector (Facebook, Amazon, Netflix and Google) for past 2 years, but as small percentage positions for clients with a more aggressive profile. Below we will take a deeper dive into the “FANG” stocks as they can present a tremendous opportunity but one not without a very high degree of risk.
Bond Market Commentary
The primary narrative in the U.S bond market continues to be the drumbeat that higher rates “are coming.” Short term rates have risen drastically on the heels of Fed tightening. Short term U.S. credit yields are above 3% for the first time in years, which has attracted both cash-like assets and assets from the equity markets that are looking for a modest return and a lower risk profile. Credit yield is the yield an investor can earn in a corporate, mortgage or other type of bond with a risk profile greater than the U.S Treasury. Essentially, this is the yield of the U.S. Treasury plus the premium needed to attract an investor to a bond with additional risk.
We believe the Fed is walking a tightrope. They have raised short term rates 7 times since this cycle began, but we think they are close to being stuck in a tight place that may limit their maneuverability. The Fed needs to continue “normalizing” monetary policy by continuing with the rate increases, but they also fear that too many increases will put downward pressure on continued U.S economic expansion. We continue to feel that there is modest chance of an inverted yield curve within 18 months, which typically signals a slowdown or recession. We’ll be watching the curve closely. Here are where Yields stand now.
U.S. Treasury Yields on August 15th
Fed Funds Target: 2.00%
2 Year Treasury: 2.62%
5 Year Treasury: 2.74%
10 Year Treasury: 2.87%
30 Year Treasury:3.04%
This yield curve scenario makes our decision regarding our desired fixed income maturities and duration an easy one. We like the 2-4 year window as we are not getting paid to take additional risk by extending out the curve. Longer bonds are more sensitive to rate increases and right now the yield difference between 2yr and 30yr US Treasuries is 42 basis points. Simply put, would you take 42 basis points and increased risk to lend the government money for an additional 28 years? Of course you wouldn’t and we won’t either, so for now, you’ll notice shorter duration holdings across our bond portfolios.
We also continue to avoid large exposures to the high yield sector. We have seen liquidity in lower credit quality bonds decrease over the past few weeks and that gives us pause when considering the high yielding, riskier areas of the bond markets. We have been investing in bank loan portfolios, which usually offer a higher yield than investment grade corporate bonds. We like this space but continue to watch the positions closely for any signs of weakness in credit quality or spread widening.
If you follow the financial media or tend to turn on CNBC during the day, you have most certainly noticed the publicity regarding the term “FANG Stocks.” So, what are the FANG Stocks? FANG is the acronym for four high-performing technology stocks to include Facebook, Amazon, Netflix and Google (now Alphabet, Inc.).
In the group of FANG stocks, we have been buyers of Amazon and Google/Alphabet over the past few years. We did not buy Netflix during its spectacular run up over the past few years. While we like the business model of Netflix, it is against our ethos to buy a stock at such a high P/E ratio.
Our team took a close look at adding a position in Facebook when their data privacy issues came to light in the Spring. The privacy issues gave us pause, and despite a large price depreciation we stayed away. After watching the price action over the past few weeks we are very glad we continued to stay away from the stock. On Thursday, July 26th, Facebook had the single worst day in the history of the stock market. The company lost $120 billion in market cap as its stock fell about 20%. This drop was caused by lower than expected user growth and reduced guidance for future growth. We weren’t surprised to see a Facebook downturn, but a 20% move down is greater than we would have expected in this market. Volatility such as seen in Facebook is almost always a warning sign for trouble ahead.
The companies that comprise FANG are some of the best growth stories that the market has ever seen and they are truly disruptive companies. That said the stocks need careful and continuous evaluation when considering opportunities for investment.
New Institutional Mandate
Copper River advises and manages both high net worth and institutional portfolios. The firm is pleased to announce that it has won a mandate for investment management for a large power and utility company in Texas. The mandate covers consultation and daily portfolio management for a $150 million dollar fixed income portfolio.
Copper River was able to use its collective 60 years of institutional fixed income experience to beat out some of the largest banks and advisory firms to win the client. We will be working alongside Agincourt Capital Management (Agincort Capital Management) out of Richmond, Virginia in providing comprehensive portfolio management, reporting, and client servicing for this large institutional client.
In conclusion, we thank you if you read this entire newsletter and we thank you for your business if you are a client of the firm.
Please feel free to reach out to us at anytime with questions or concerns.
-Team Copper River Advisors