Q2 letter: A sugar high

Q2 letter: A sugar high


We hope you’ve had a good start to the summer.

The interest rate outlook has changed considerably since the beginning of the year. Investors entered  2019 with an expectation the Fed was likely to continue raising rates over the course of the year. However, recent comments from Fed officials have made rate hikes far less likely. There seem to be three factors influencing  this sudden shift in Fed policy. The first is gathering signs of a softening economic activity across the world (the IMF estimates countries representing 70% of the global economy will slowdown in 2019). The second is continuing uncertainty surrounding the US’s trade policies. The last is the political pressure being placed on the Fed, mainly expressed in the form of public statements and tweets from the president as we head into a presidential election next year. Rate cuts at this juncture would prolong the rally and the current economic expansion, aiding the administration’s prospects in 2020. Though other administrations have tried to coax the Fed, they’ve done so more quietly. We don’t know whether Fed officials will find Trump’s more public approach tougher to ignore. The bond market itself seems to be anticipating cuts, the yield curve is “inverted”, i.e. near-term rates are lower than those further out. This has historically been an accurate indicator of an upcoming recession.

As we begin the third quarter, the stock market remains close to all time highs, with the S&P 500 hovering at just under 3000 points. Despite some turbulence, stocks continue to be led by the technology sector, which is now over 26% of the S&P 500’s market capitalization. That factor has only been higher once, during the peak of the tech boom when it crested over 30%. The Nasdaq, which contains a large number of technology companies, is above 8000, an all-time high. However, there are some indications that the technology rise has run its course. This year has seen a steady spate of large technology IPOs for companies that have grown privately over the past ten years. This includes: Lyft, Uber, Slack and Pinterest among others.  Historically, such a spate of stock sales has been an indication that professional tech venture capital investors see the current price environment as a high-watermark, and an ideal time to exit investments that have grown in value for several years.

In general, the economy remains at very high levels of capacity utilization. Unemployment remains at a multi-decade low and wages rose swiftly in the past two quarters. The manufacturing and services sector remain at high levels, but growth in new orders has slowed. The purchasing managers indices for both manufacturing and services fell below 51 (a level of 50 indicates no growth). Anecdotal reports suggest the weakness is at least partly due to trade uncertainties. Consumer confidence also remains high, despite a sharp drop in May. 

Our general view remains that investors should exercise caution. We continue to recommend a defensive allocation with greater exposure to high quality bonds and lower exposure to risk assets.  


Subir Grewal, CFA, CFP                                                                     Louis Berger

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