Quarterly Letter

”The man who moves a mountain begins by carrying away small stones.”

- Confucius

“When a long-term trend loses its momentum, short-term volatility tends to rise. It is easy to see why that should be so: the trend-following crowd is disoriented.”

- George Soros

During Q3 2019, “haven” assets were strongest among the primary asset classes.1 This followed a similar pattern from the second quarter. Long-dated US Treasury bonds led the way in the third quarter gaining 8.4%. Gold was up 4.3%. On the “risky” asset front, equities posted a modest gain of 1.8%. Commodities lost value in the third quarter, just as they did in the second quarter, down 3.8%. For the full year-to-date, all four primary assets remain positive, and meaningfully so: equities are up 20.4%, long-dated US Treasury bonds gained 19.7%, gold increased 14.5%, and commodities improved 7.4%.2

For additional benchmarking purposes, we can look at a global equity index and a broader bond index to get the most comprehensive perspective. The MSCI All Country World Index3 is up 16.4% year-to-date. The iShares Core US Aggregate Bond Index4 is up 8.3% year-to-date. A typical 60/40 mix is therefore up 13.2%.5

Equities ended the quarter positive, but it was a volatile three months. The S&P 500 made a high of 3026 on July 29 only to drop 6% in six trading days to 2847. The index then rallied back to 3022 by September 19 only to fall 5.5% to 2856 on October 3. Since then the index has continued to rally, ending the month at 3047 on October 31 and continuing to make new all-time highs as we write.

Given the significant year-to-date double-digit gains, is the recent equity market volatility a sign equity indices have come too far too fast and are at risk of a retracement? Manufacturing data in both the US and Europe show signs of a slowdown, it appears likely Q3 of 2019 will be the third quarter in a row for year-over-year declines in corporate earnings, and the “trade war” with China has clearly been distracting. On the other hand, some investors believe the Federal Reserve (along with other central banks) rate cutting will be stimulative. Our favorite gauges of market sentiment, credit spreads and Lowry’s market breadth indicators are relatively benign – supporting modest equity market increases.

1 The ratio of BBB to AAA yields has essentially moved sideways for a year and remains well below the 150% level where HCWE & Co. suggests a recession is probable.

Gold, on the other hand, is indicating a significant change and a meaningful pickup in inflation. When we wrote to you last quarter, we explained how we increased portfolio exposure to gold (via GLD) in early July as gold started to show year-over-year increases.

2 On the inflation front, gold is up significantly on a year-over-year basis.