*This report was written October 1, 2019


A review of third-quarter investments offer subdued results; however, that does not reflect the path the investment markets took the past three months. The quarter was filled with major headlines, including two interest-rate cuts by the Federal Reserve Bank (Fed), the S&P 500 Index hitting an all-time high, and the inversion of the yield curve.


Generally speaking, investment portfolios were flat or slightly up for the quarter. The lone bright spot were domestic REITs (real estate). The Dow Jones REIT Index was up almost 7%. REITs benefited from the Fed pushing interest rates lower. Large cap U.S. stocks, domestic aggregate bonds, and foreign bonds posted low but positive returns, while small cap U.S. stocks, foreign stocks, and commodities posted slightly negative returns. During the quarter, the S&P 500 Index hit a new all-time high in late July, before losing ground in August. The index then moved higher in September, closing just 1.60% below its all-time high.[1]


There were a number of significant events during the quarter. The Fed cut interest rates twice. These were the first interest rate cuts in ten years. It reinforces our belief that the Fed is paying attention to global economic issues and attempting to be accommodative with policy to support domestic economic growth.


Another noteworthy event during the quarter was the inversion of the yield curve. This is measured by charting the two-year Treasury bond against the 10-year Treasury bond. The U.S. government issues Treasury bonds. A yield curve inversion happens when short-term interest rates are higher than long-term interest rates. If demand is considerably higher for long-term bonds, it pushes their yields (the interest rate) lower. This could happen because investors sell stocks and shift the money to bonds, the Fed has kept short-term rates too high, or negative interest rates in other countries funneling investments into U.S. Treasury bonds.  Normally, as economic expansion ends, inflation climbs. To combat rising inflation, the Fed takes a more restrictive monetary stance, which leads to short-term interest rates rising faster than long-term interest rates. This triggers a yield curve inversion for an extended period and foreshadows a forthcoming recession.


It has been widely reported that every recession since 1956 has been preceded by an inversion of the yield curve. This is misleading on two fronts: first, information that is being disseminated insinuates that a recession is imminent, which is false. The length of time from the yield curve inversion to the recession has varied greatly, from 10 months in 1980, to 33 months in 1998[2]. Secondly, it depends on how long the yield curve is inverted for. If it were


briefly inverted, as was the case in the third quarter, it would be considered an anomaly caused by forces other than a weakening economy. Interestingly, Credit Suisse published research showing the stock market has typically rallied 15%, on average, in the 18 months following a yield curve inversion.[3]


The U.S.-China. trade war continues to weigh heavily on us, as does Brexit. There is a decent probability that the outcome of Brexit is another referendum by the people voting to rescind the previous vote of leaving the European Union in 2016. We are optimistic that a trade deal with China will be reached before year-end. There is a significant incentive to resolve this situation, as the strength of the economy will certainly factor into the 2020 presidential election. A good trade deal with China will remove some of the uncertainty we see in the market, as well as provide a boost to the U.S. economy.


To reiterate what we outlined last quarter, we are becoming more cautious in our outlook. We are beginning to see the impact of the U.S.-China trade war and the economic issues in Europe and Japan impacting the global economy. This is evident in the weakening global manufacturing data and the plunging of global interest rates. The trade tensions are affecting domestic manufacturing more than expected too. The September Purchasing Managers Index (PMI) result was the lowest since 2009 and coming on the heels of a disappointing August reading. Fortunately though, manufacturing only makes up about 12% of the U.S. GDP.  Consumer spending makes up nearly 70% of GDP[4]. The statistics that measure U.S. consumers remain favorable, albeit they have softened. The unemployment rate remains historically low, while wages are rising. As long as consumer spending stays healthy, we feel comfortable in the near-term outlook.


With all the talk of a forthcoming recession, it is good to be reminded that trying to time the investment markets is a loser’s game. There have been numerous pundits in the last 10 years talking about an inevitable market drop. For the people that listened, they missed out on what has been the longest bull market in history. In the 10 years since the financial crisis (2009-2018), the S&P 500 Index has had a total return of 243%. The best 25 trading days during that 10-year period produced 67% of that 243% gain. The 25 trading days represent less than 1% of the total trading days during the 10-year period. Thus, 1% of the trading days were responsible for a gain of 163%[5]. This is evidence of our belief that attempting to time the market is futile, while maintaining exposure to the market is essential.


We do not believe anyone can say with certainty when markets are going to drop. We recognize risks are rising, and we are certainly being cautious. Our disciplined investment process focuses on understanding your cash flow needs and personal situation. This is vital to ensuring your portfolio is invested appropriately. Having a properly allocated portfolio reduces the possibility of needing to sell assets during downturns at unfavorable prices. Making certain your investment allocation aligns with your financial plan is crucial to successful investing.



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] https://dashboards.trefis.com/no-login-required/evWYEyFQ/Inverted-Yield-Curve-Is-Recession-Coming-In-Next-20-Months-?from=forbes
[3] https://www.cnbc.com/2019/08/13/after-yield-curve-inverts-stocks-typically-have-18-months-before-doom.html
[4] LPL Research October 2, 2019
[5] MFS Investments via BTN Research September 30, 2019