There was much to like about this quarter, especially for domestic equities. U.S. stocks built on the positive momentum from last quarter. Large cap stocks led the way, with the S&P 500 Index being up 7.71%. Small and medium-sized U.S. companies also fared well during the quarter. The Russell 2000 and the S&P 400 Index were up 3.58% and 3.86% respectively. Foreign stocks posted positive returns, although they were muted compared to domestic stocks. Foreign stocks were up 1.35%. Real estate posted a slightly positive return at 0.72%. Core aggregate bonds were mostly flat for the quarter at 0.02%, while municipal bonds were slightly negative for the quarter at -0.15%. Foreign bonds, commodities and emerging market stocks all struggled, posting returns of -1.09% to -2.02%.[1]


This was the best quarter for large cap U.S. stocks since the fourth quarter of 2013. Tensions related to trade, which were at the forefront during the second quarter, were usurped by a renewed focus on economic data and corporate earnings. Large cap U.S. stocks hit a noteworthy milestone during the quarter; we are officially in the longest bull market in U.S. stock market history[2]. You might be wondering what all the commotion is about. Simply put, it has been quite some time since we have seen a market drop of 20%, which is considered a bear market. The quarter was also the 10-year anniversary of the collapse of Lehman Brothers[3], which foreshadowed the financial crisis that unfolded. This period is widely referred to as the Great Recession, as it was the most significant economic downturn since the Great Depression.


As expected, the Federal Reserve Bank (Fed) raised its benchmark interest rate at its most recent meeting by a quarter point. This marks the third increase this year and the eighth since 2015. Higher short-term rates are not necessarily bad for stock returns. Rising rates are indicative of the Fed’s confidence that the economy is strong. Chairman Jerome Powell reaffirmed the Fed’s strategy when he gave remarks at the annual Jackson Hole conference in August. He explained the Fed would continue the gradual normalizing of monetary policy, which would include telegraphed-continued increases in the short-term rates. Chairman Powell’s remarks were considered fairly dovish, as he indicated a need for the Fed to carefully balance their dual mandate – maximizing employment and keeping prices stable. The Fed must navigate between raising rates too quickly and cutting short the economic expansion, and also raising rates too slowly and allowing inflation to get out of control. It’s widely expected the Fed will raise short-term rates again in December, followed by three more increases in 2019.


While we continue to be comfortable in the near-term economic outlook, we are becoming more concerned over a few structural issues that are looming. The total outstanding national debt is greater than the GDP of the country. The national debt is about $21.5 trillion4, while GDP is estimated at $20.5 trillion[4]. For us, the concern is not so much the debt-to-income ratio, but more so at the speed at which they are moving apart. This will be compounded with higher interest rates. It is anticipated that interest payments on the national debt will make up about 8% of the total government spending in 2018. Government is spending considerably more than they are taking in each year. For the fiscal year 2018 (Oct 2017 – Sept 2018), the total government spending is forecasted to be about $4.1 trillion5. The forecasted revenue will amount to about 81% of the amount needed, so they have to borrow about 19%[5]. That 19% gets added to the national debt.


The overall fundamentals of the economy are still fairly solid. Inflation remains low and despite the recent increases, short-term interest rates remain at historically low levels. Companies have continued to produce good earnings, and we continue to see strength in the job market. There are reasons to stay upbeat about near-term investment expectations. Markets go up, and they will eventually go down in the future. It is important to remember stock prices are an economic indicator of the overall strength of the economy. Although we hate seeing negative returns, they are a necessity for a healthy economy. Frankly, negative returns do not worry us nearly as much as recessions do. Recessions create many more problems than negative investment returns. In our assessment, we are in the late stages of the economic expansion cycle. While we do not expect to see the investment markets reproduce the results from the last few years, we believe returns will continue to be positive.


It is worth noting that we cannot, nor anyone for that matter, say with any certainty exactly when the next market drop is going to occur; however, we can prepare for them by making sure your investment portfolio allocation is in harmony with your financial plan. Having a properly aligned portfolio allocation and financial plan reduces the possibility that we will be forced into selling assets during market drops at unfavorable prices. A key to successful investing is to be buyers of investments when others are forced to sell. To paraphrase Warren Buffet, we should be greedy when others are fearful. There are many factors that we assess to form our opinion.


Warmest regards,


The Waller Team



The opinions voiced in this letter are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in this printing may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Stock investing involves risks, including loss of principal. Bond values will decline as interest rates rise and bonds are subject to availability and changes in price. There is no guarantee that a diversified portfolio will enhance overall return or outperform a non-diversified portfolio. Diversification does not protect against market risk.


[1] Morningstar Office: Large Cap U.S. stocks as measured by the S&P 500 Index, Medium Cap U.S. stocks as measured by the S&P Mid Cap Index and Small Cap U.S. stocks by the Russell 2000 Index. Foreign stocks as measured by the MSCI EAFE ND Index and the Emerging market stocks measured by the MSCI EM ND Index. Fixed Income/Bonds as measured by the Barclays U.S. Aggregate Bond Index, Barclays Municipal Index, and the Citi World Government Bond Index. Real estate as measured by the Dow Jones U.S. Select REIT Index. Commodities as measured by the Bloomberg Commodity Index. Inflation as measured by the U.S. BLS Consumer Price Index All Urban SA 1982-1984.
[2] ;
[3] ;
[5] JP Morgan Guide to the Markets 09/30/2018