Inverting Yield Curve Hasn’t Derailed Rally – Yet

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Inverting Yield Curve Hasn’t Derailed Rally – Yet

Stock markets around the world continue to recover from the sharp sell-off in the fourth quarter of last year, though the rally showed signs of slowing down in March as foreign stocks, small-cap stocks and even value-oriented U.S. stocks could not keep pace with the S&P 500. Even the Dow Jones Industrial Average was essentially flat for the month.

Bonds of all varieties continued to gain, even if they could not keep up with their more aggressive stock counterparts.

This is all good news for investors as they recoup the losses from 2018. However, we can’t help but question the ongoing enthusiasm for stocks in the face of three risks that could derail this rally. One risk is the ongoing trade dispute with China, which continues without any apparent end in sight even as politicians tease us that progress is being made. Investors seem confident that a deal will be made, but is that confidence misplaced?

Second, signs of a slowdown, both globally and in the U.S., continue to build. Fourth-quarter GDP (measure of overall economic growth) was reduced to 2.2% recently, well below the 3% target held out by the administration. And forecasts for first-quarter GDP are now in the 1.5% range. Investors believe the economy will accelerate later in the year, but again, we wonder where confidence of a rebound is coming from.

Finally, in March the yield on a three-month Treasury bill was higher than that on a ten-year Treasury bond. This is known as an inversion because typically one would expect a longer term bond to yield more than a shorter term bond (to compensate for having one’s money tied up for a longer period of time). Historically, an inversion often happens before the economy slips into a recession.

The good news is that there is usually a long lead time between an inversion and the point at which the economy slips into recession, so there may be an opportunity to make money before stocks reverse course. Also, not every inversion is followed by a recession, so the present situation does not necessarily indicate a looming recession. Right now investors seem pretty confident that stocks have further to run. While we understand the optimism, we remain a bit skeptical that it’s all smooth sailing from here.

As stocks have rebounded, we have been moving the FSA portfolios back to a fully invested position. In general, each strategy holds roughly 80% of its maximum equity allocation. We have been holding on to the last 15% to 20% in money markets until stocks can break out of the year-long trading range.

The bottom line: The S&P 500 index is close to breaking out of its 15-month sideways landing. We want to make some hay while the sun is shining, but clouds could be coming soon.

Portfolio Update
Keep in mind that because we manage clients’ portfolios individually, the results for your particular accounts may differ somewhat from the averages.

Income (Strategy 1)
After providing a relative safe haven in 2018, bonds have lagged (as expected) the strong return from stocks in the first quarter. During the quarter, we added high yield bond funds back to the portfolios, as this area rebounded strongly from the December sell-off. As we enter the second quarter, the Income portfolios hold 40% in high yield and foreign bonds, with 45% in higher quality intermediate-term funds and 10% in a high yield municipal bond fund. The money market position is only 5%.

Income & Growth (Strategy 2)
As stocks rallied in January and February, we began to add equity funds back to the portfolios, as well as high yield bond funds and a high quality intermediate-term bond fund. As we enter the second quarter, the portfolios hold 35% equities, 30% high yield bond funds, 30% high quality bond funds and only 5% in money markets.

Conservative Growth (Strategy 3)
There was a good deal of activity in our flagship strategy as we moved the portfolios from 75% money markets to roughly 15% money markets. After dropping the inverse fund in January, we began adding high yield bond and equity funds to the portfolio as stocks continued to rally. As of the quarter’s end, the portfolios hold roughly 60% in equities, 25% in bonds and 15% in money market funds.

Core Equity (Strategy 4)
It has been a busy six months for the Core Equity portfolios as we raised cash in the fourth quarter and have been reinvesting that cash in the first quarter. After selling the inverse fund in January, we have been steadily adding to equities as stocks have recovered from their deep sell-off. As we continue into April, these portfolios hold around 85% in equities, with 15% in money market funds.

Tactical Growth (Strategy 5)
From a position of nearly zero percent exposure to stocks, this strategy has been moving again toward being fully invested. In addition to broad market exposure, we have added an emerging markets fund, a technology fund and a Treasury bond fund. In addition, we sold the Brazil position and reduced the gold fund. Currently, these portfolios hold roughly 45% in diversified equity funds, 30% in various sector funds, 5% in emerging markets, 5% in a Treasury bond fund and 15% in money market funds.

Sector Rotation (Strategy 6)
It has been a strong start to the year for this all-equity strategy. The inverse S&P fund was dropped in the February rotation, so the portfolios have captured most of the market’s gains for the year. During the April rotation, the portfolios hold leisure, retail, industrials, consumer staples, financial services and energy services.

Please remember to inform your advisor of any changes in your life that could affect your investment objective and how we manage your money.

FSA Investment Team

Disclosures: Past performance is no guarantee of future results. Different types of investments involve varying degrees of risk. It should not be assumed that future performance of any specific investment, investment strategy or product (including the investments and/or investment strategies recommended and/or undertaken by FSA or the FSA Safety Net®), or any non-investment related services, content or advice, will prove successful or profitable, or equal any historical performance level(s).

The FSA Safety Net® is designed to represent an exit point for securities within a portfolio to help reduce losses during sustained downward trends. The FSA Safety Net® is not effective and will not protect assets in periods leading up to and including abrupt/sudden market downtrends. Examples of such occurrences include, but are not limited to, the market crash of October 1987, the market drop in October 1989, the market disruption caused by the terrorist attacks of September 2001 and the flash crash of May 2010. Similar future occurrences could reduce the effectiveness of the FSA Safety Net®.  In addition, the FSA Safety Net® will not protect assets in the event that the account custodian, mutual fund sponsor or manager, annuity sponsor or manager, a specific security itself and/or the stock exchanges, at their discretion, suspends, disallows, or fails to conduct trades, exchanges, redemptions or liquidations requested by FSA or you.

Inverse/Enhanced investments: FSA may utilize inverse (short) mutual funds and/or exchange-traded investments/funds (ETFs) that are designed to perform in an inverse (opposite) relationship to certain market indices (at a rate of one or more times the inverse result of the corresponding index). In addition, FSA may also use leveraged (enhanced) mutual funds or ETFs that provide an enhanced relationship to certain market indices (at a rate of more than one times the actual result of the corresponding index).  You may direct FSA, in writing, not to employ any or all such investments.

Due to various factors, including changing market conditions or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this communication serves as the receipt of, or as a substitute for, personalized investment advice from FSA.

FSA is not a law firm, accounting firm or an insurance agency, and no portion of FSA’s services should be construed as comprehensive financial planning or legal, insurance or accounting advice. Rather, you should seek the advice of your attorney, insurance agent, accountant or other corresponding professional advisor with respect to such issues.

FSA’s current written Disclosure Brochure and Privacy Notice discussing our current advisory services and fees is available at www.FSAinvest.com/disclosures or by calling 301-949-7300.

Please remember it is your exclusive obligation and sole responsibility to immediately notify FSA, in writing, if there is a change in your financial situation or investment objective(s) including, but not limited to, personal/financial situation, goals, needs or concerns/views regarding economic/political/financial climate as well as any changes in investment alternatives, restrictions, etc. for the purpose of reviewing, evaluating or revising any of FSA’s previous recommendations and/or services.

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