Monthly Archives: April 2019

Last Week Today: In an effort to cut off Iranian oil exports and further isolate the country, the White House announced the end of waivers that had allowed eight countries to buy Iranian oil. The price of crude initially jumped on supply concerns (Iran currently exports approx. 1.2 million barrels per day) but fell later in the week when President Trump told a crowd he placed a call to OPEC demanding they bring down the price of oil. | Former Godfather’s Pizza CEO Herman Cain withdrew from consideration for a seat on the Federal Reserve. | Viewed as a bellwether for technology and manufacturing, South Korea’s GDP unexpectedly declined 0.3% in the first quarter, another indication that synchronized global growth has given way to synchronized slowing. | Q1 GDP came in at 3.2%, though the headline value belies slower economic growth – more on the GDP release below. | The Fed convenes this week for their third meeting of the year, but a change in interest rates is extremely unlikely.

Approximately seven months after their last respective all-time-highs, the S&P 500 (+1.2% for the week) and Nasdaq Composite (+1.9%) indices both ended the week at record levels. International stocks trailed their domestic counterparts with European and Japanese stock indices eking out small gains, while China’s main equity index declined -3.4% for it’s worst weekly performance since October. After a brief period of inversion between key U.S. Treasury bond maturities (10-year/2-year and 10-year/3-mo), the yield curve has steepened over the last four weeks. Although the curve remains very flat, it has at least regained a less troubling upward sloping shape. In the commodity complex, precious metals rose (Gold +0.8%, Silver +0.4%), while Dr. Copper (-1.2%) and WTI Crude (-1.9%) declined on the week. WTI crude closed the week trading at $62.80 per barrel. The VIX Index (a measure of investor anxiety) is a low 12.7, down 50% from the beginning of the year following the financial market turmoil of Q4.

For specific weekly, month-to-date and year-to-date asset class performance, please click here.

Follow the Leader. Global central banks are shadowing the Fed’s shift away from a tightening bias. Last month the European Central Bank announced a delay in their intent to raise interest rates until at least 2020. The Bank of Canada left rates unchanged for the fifth consecutive meeting last week, and surprised markets by suggesting they are open to cutting rates if necessary. On Wednesday, the Bank of Japan pledged rates would stay low until “around Spring 2020”. On Thursday, Sweden’s central bank (The Riksbank) pushed out its next rate hike until 2020 or possibly later, after signaling it would raise rates later this year only a few months ago. In light of slowing economic growth, investors have been ignoring central bankers’ tightening bias, pushing global yields lower. The amount of negative-yielding bonds in the Barclays Global Aggregate Bond Index rose more than 50% from September to nearly $10 trillion today (source Bloomberg).

Q1 Earnings Update. With nearly half of S&P 500 companies reporting Q1 earnings thus far, results are exceeding expectations as management teams did an excellent job of issuing lukewarm guidance over the last several months. In a difficult comparison to Q1 2018 (which benefited from the initiation of the new corporate tax-cuts), aggregate Q1 Earnings Per Share is tracking toward flat year-over-year. No growth doesn’t sound very good until you consider analyst consensus estimates were for Q1 earnings to contract by -2% (Source: Goldman Sachs). Earnings season continues this week with another 30%+ of S&P 500 companies reporting Q1 results.

Q1 GDP Update – All that Glitters… The first estimate of Q1 GDP showed an upside surprise of 3.2% annualized real growth, vs. the consensus estimate of 2.3%. Upon closer inspection, however, critical indicators of the health of the U.S. economic engine showed weakness. Indeed, FTN’s Chief Economist Chris Low quipped “Friday’s GDP report was the weakest 3.2% quarterly growth increase we’ve ever seen.”

  • Domestic sales only grew by 1.3%, half the pace of Q4 2018 and the slowest since Q2 2013.
  • Growth in inventories added 0.7% to Q1 GDP. In light of slow demand, the boost that inventories provided in Q1 will be a drag in the coming quarters as companies must clear their warehouses of the excess product before re-ordering.
  • Inflation-adjusted Business Fixed Investment declined from 5.4% to 2.7%.
  • The most substantial portion of the economy, Personal Consumption Expenditures (PCE) downshifted to 1.2% in Q1 (vs. 3.5% in Q3 and 2.5% in Q4 2018). The government shutdown and weather-related factors may have negatively impacted PCE, but we won’t know for several months as new data is released.
  • Headline PCE Inflation slowed from 1.5% to 0.5% and Core PCE Inflation fell to 1.3%. The GDP deflator, which measures prices of domestically produced final goods and services, fell to just 0.6%. Low Q1 inflation flattered the already weak real levels of Business Fixed Investment and Personal Consumption Expenditures.


Bottom Line: Since the Financial Crisis, Q1 has typically been the weakest quarter for growth, but that pattern is unlikely to hold in 2019. Indeed, Q1 may represent the most robust aggregate growth in 2019 as we expect full-year GDP to track between 2% – 2.5% in a continuation of the “Good, but not great” economic environment characterizing the post-Financial Crisis recovery. Regardless of the strength of the expansion, it appears to be a safe bet that it will become the longest on record when it enters its eleventh year in June.

Be well,


Synopsis 2019.04.12

Last Week Today:  U.S. Trade Representative Robert Lighthizer proposed tariffs on $11.2 billion of European Union products (e.g., fish, cheese, wine, airplanes) in retaliation for subsidies paid to Airbus SE. | The International Monetary Fund revised growth expectations lower for the U.S. (2.5% à 2.3%) and the global economy (3.5% à 3.3%).  |  Initial jobless claims in the U.S. declined to levels not seen since 1969 (see chart below). | Some guy named “Tiger” won his 5th Master’s Tournament.

Global equities moved higher last week with the U.S. leading the way. The major domestic indices tacked on weekly gains of 0.6% at the start of Q1 earnings season, and at the half-way mark in April, markets are up about 3%. As of Friday, the S&P is only 0.8% below it’s September high, with the DJIA (1.6%) and Nasdaq (1.6%) indices not far below all-time highs either. International equity markets recorded slightly lower weekly gains but are pacing U.S. indices on a month-to-date basis. In fixed income markets, US Treasury yields rose and, importantly, the yield curve uninverted at the key points that signal an imminent recession: 10-year/2-year bond maturities and 10-year/3-month maturities. WTI Crude gained 1.3% for the week and, at $63.89 per barrel, the price of crude is up 40% year-to-date.

For specific weekly, month-to-date and year-to-date asset class performance, please click here.

You’re Not Fired. According to the Wall Street Journal, in a phone conversation the week of April 1, President Trump told Fed Chairman Powell “I guess I’m stuck with you.” Far from an endorsement of his work, at least it implies that the President will not take measures to remove Powell from the Fed – a move that would be detrimental to the markets in the short-run and lethal in the long-run to the independence of the Federal Reserve as an apolitical institution. While Trump apparently won’t seek to remove Powell, he is trying to stack the Fed with committee members sympathetic to his views and put forth political loyalists Stephen Moore and Herman Cain as candidates to fill open seats at the Federal Reserve.

Exodus – Investors’ preference for passive over active funds continues unabated as detailed in the chart below. Yes, passive funds have trounced most active managers over the last several years, but that is not new news as the track record of the average active manager relative to his benchmark has been poor for decades.


In the active vs. passive discussion, it’s worth considering that investors cannot invest directly in any index. That is, investors can only gain exposure to an index through an investment product such as a mutual fund, an ETF, or some other type of vehicle[1], all of which have embedded expenses (management fees, trading costs, administration fees, etc.). Hence, passive index mutual funds and ETFs also lag their benchmarks due to fees. However, since they charge lower fees, the underperformance of passive strategies tend to be less pronounced than the average active manager.

Covenant’s position in the active vs. passive debate is to rely on passive management for the most efficient markets but to consider active management options in sectors or geographies where markets are less efficient. That being said, a lack of market efficiency only offers a clue for where to begin searching for active strategies. Because passive strategies offer exposure at such a low cost, any active manager that makes it into a portfolio must exceed high standards. While historical performance is an important consideration, it is only one part of the selection process. Qualitative assessments of the strategy, investment process, buy/sell disciplines, and the people involved play a more significant role than is generally recognized.

Managers that can successfully beat the market over a multi-year timeframe are rare, but worth the search (and paying higher fees). For example, all else being equal, everyone would rather pay fees of 0.32% per year vs. 0.89% per year for portfolio management. However, would you feel the same way after reviewing the table below which shows the actual results of a manager (who shall remain anonymous for compliance reasons) vs. a low-cost, passive index ETF and the benchmark?


While one should always seek the lowest cost option when comparing comparable strategies, sometimes you get what you pay for. In this case, paying an extra 0.57% per year in portfolio management fees for the active manager would have netted a 51% greater return on the investment.

Whether you favor passive or active investing is less critical to long-term success than maintaining the discipline to ride out the inherent volatility of financial markets. Paraphrasing a speaker at a recent Dimensional Fund Advisors Investment Conference about successful investing: “It matters less about how your portfolio looks, but more about how much you look at your portfolio. Like a roller coaster ride, investing can be scary, but the only time it is truly dangerous is when you try to get off in the middle of the ride.”

Be well,


[1] An investor could avoid using an investment product by replicating an index herself. While that would avoid paying a management fee, it would not eliminate the costs of trading to establish the initial positions and rebalance the portfolio as the target index holdings and respective weights change over time.

Last Week Today. President Trump suggested he will nominate Stephen Moore to the Federal Reserve. A loyalist to the President, Moore called for Fed Chair Powell’s resignation after the Fed raised rates last December. In an interview last week with the New York Times Moore called for an immediate 50bps cut in the Fed Funds rate, though he said he would also try to make amends with Chairman Powell. | Data collected during the first quarter by the privately held, independent firm China Beige Book showed an “unmistakable” credit-fueled recovery in the Chinese economy. | Bloomberg News reported US representatives are working through the draft text of the China/US trade agreement line-by-line to ensure there are no discrepancies after US officials noticed the Chinese version omitted commitments made by negotiators. Whether this is an example of Chinese subterfuge or an honest mistake, the inconsistencies may be why President Trump signaled he is not rushing to close a deal.

The S&P 500 closed out Q1 2019 with the largest first-quarter gain (+13.6%) in more than 20 years.  The impressive performance follows the growth-scare scarred fourth quarter, which was the worst quarter (-13.5%) since the Financial Crisis and included the poorest December monthly performance (-9.0%) since the Great Depression.  Nevertheless, at a CFA event on Friday Thomas Lee, of research firm Fundstrat, made the case that 2019 could look like 2009, a year in which equities jumped more than 25%. We’ll happily take a 25% gain if we can get it, but there have been eleven first quarters in which the S&P rose double digits and the average return over the final three quarters has been 5.8% (source LPL).

For detailed weekly, month-to-date and year-to-date asset class performance, please click here.

GDP Update. Q4 GDP was revised down from 2.6% to 2.2% (consensus estimates were 2.3%), reflecting weaker personal consumption expenditures, nondefense federal government spending, and nonresidential fixed investment. A growth rate of 2.2% is in line with the post-Financial Crisis trend and consistent with our “Good, but not great” theme for an expansion that, barring a recession in the next few months, will tie for the longest on record in June of this year.



As anticipated, Q1 is shaping up to be a relatively weak quarter of sub-2% growth.






Imperfect Science. According to the Merriam-Webster dictionary, science is defined as “knowledge or a system of knowledge covering general truths or the operation of general laws especially as obtained and tested through scientific method.” I highlight this definition as too frequently people treat economics as a true science with immutable laws akin to the effects of gravity as defined in physics. I was reminded of this on Friday at the 5th Annual CFA Societies of Texas Investor Summit.

Among the notable speakers were two economists David Rosenberg (Chief Economist and Strategist for Gluskin Sheff) and Joseph Kalish (Chief Global Macro Strategist for Ned Davis Research). Both Mr. Rosenberg and Mr. Kalish are highly educated and respected professionals. They have access to the same economic data, but their interpretation of the data and the implications for the economy and financial markets are dramatically different. Below is a summary of their presentations.

David Rosenberg, Gluskin Sheff

  • The yield on one-month US Treasury Bills has risen with Fed rate hikes. When the one-month yield rose above the dividend yield of the S&P 500 in Q3 2018, it was the first time in a decade and marked the top of the equity market.
  • The level of interest rates is not what matters – it’s the change. The Fed raised rates 9x, and there are lagging effects that will continue to impact the economy this year and in 2020.
  • The effects of fiscal stimulus on the economy were mitigated by the massive overhang of debt in the U.S.
  • High debt and demographics (and technology) have been pushing the neutral interest rate lower for a long time now. The neutral rate is below 2% (the Fed believes it’s 2.5% – 2.75%). The Fed has over tightened already.
  • The Schiller Cyclically Adjusted Price-to-Earnings (CAPE) ratio shows that this is the third highest priced market in history.
  • Corporate balance sheets are where the bubble is this time in thee economy. Corporate debt to GDP is higher than it has ever been. Debt to EBITDA is even higher relative to history. Triple BBB bond growth ($3T in total) has led to the junkiest investment grade market of all time – 30% of BBB corporations have a junk bond rating based on leverage ratios. A record amount of corporate debt is coming due beginning this year and over the next five years (refinancing $7T in total) – more than $1T per year. Credit spreads will move wider unless corporate America goes on a debt diet.
  • The next recession will be led by corporations, similarly to 2001.  The recession of 2001 was one of the mildest recessions in history, but equity markets got hammered.
  • Currently on month 117 of the expansion – if we get to July it will become the longest expansion in history.
  • The yield curve is his favorite recession indicator. The inversion has him on high alert, even though the economic situation is different with low rates and the large Fed balance sheet. He also looks at the unemployment rate, which has ticked up.

Conclusion: Based on Gluskin Sheff’s economic indicators, Rosenberg believes we are 91% through the economic expansion, and we will be in recession by the end of 2019. Rosenberg recommends investing in cash, long duration government bonds, and dividend aristocrat stocks. He also suggests avoiding emerging markets, equities, and broad S&P 500 exposure.

Joseph Kalish, Ned Davis Research

Thus far in this cycle, the cumulative GDP increase has been average relative to other recoveries, but the time to achieve this level has been twice as long. To Kalish, the slow rate of recovery implies that excesses have not built in the economy.  Also, Kalish doesn’t believe the yield curve is the end-all recession indicator, as it’s an ineffective signal in international markets.

Kalish’s approach to economics deconstructs the economic cycle into sub-cycles because the US economy is large and complex.  Of their ten indicators, the only one flashing a recessionary signal is the Confidence Board’s CEO Index. However, this survey was taken in Q4 when Trump was talking about firing Fed Chair Powell, the Fed was hiking rates (with no end in sight), and trade rhetoric was high.

  • Financial Conditions – The real (inflation-adjusted) Fed funds rate has always been higher at the end of economic cycles. The historical average real rate has been 3%, but today it is 0%.
  • Credit Cycle – Credit conditions remain supportive of economic growth. He shows only 5% total credit growth (YOY) on average during this recovery, which is very low. The lack of credit creation thus far this cycle will extend the economic cycle.
  • Profits Cycle – Profits typically peak well in advance of recessions. Data released on Thursday showed corporate profits just made another new high of 11.9%.
  • Labor Cycle – Jobs and income sustain the consumer, and he sees no evidence of problems here.
  • Demographics Cycle – Pretty early cycle with regards to the number of available middle age and young-adult workers.
  • Auto Cycle – Late cycle and in a downtrend. He offered reasons why slowing vehicle sales may not reflect the broader manufacturing sector, including Millennials living in cities, ridesharing, etc.
  • Housing Cycle – Sees housing as contributing to growth in 2019 vs. a drag like it was in 2018.
  • Capital Expenditures Cycle – usually peaks at the end of the cycle. He believes we are late cycle in this sub-cycle, but that capex could pick up as management teams become less concerned about trade and economic outlook.
  • Fiscal and Trade Cycles – Tax reform will continue to have a positive impact through 2022
  • Trade & Current Account Cycle – Improvement in oil exports has offset deterioration in non-energy trade.

Conclusion: The US economy is closer to mid-cycle than late cycle and recommends corporate bonds and equities, particularly emerging market equities.

Two economists with access to the same data drawing two very different conclusions about the economy and how to invest going forward. The variance in these views highlights the challenge of making accurate economic forecasts. Even though the US economy is an open system (i.e., influenced by other economies), the global economy is a closed system, meaning that it is not subject to external forces that can alter outcomes. In the scientific world, closed systems are relatively easy to analyze, and outcomes can be calculated precisely.

Economics is different, even when considered on a global basis because although it is closed in the physical sense, human behavior represents an external force that influences outcomes and human behavior cannot be calculated precisely. Trillions of individual decisions over the course of a business cycle influence economic outcomes from Congress passing laws that impact corporations, to management teams determining how many employees they need, to consumers choosing to rent vs. buy homes. There is no model or set of models capable of perfectly assimilating this data nor predicting the cumulative effects. Hence, most economists acknowledge (even if they won’t admit it publicly) that their study is an imperfect science where general forecasts are far more accurate than precise ones.

This reality is important to remember, as the Fed is a giant economic think-tank. Although the Fed’s access to data is unparalleled and their collective intellectual firepower is unsurpassed, they are prone to misinterpreting data (like all economists). Hence, the more flexible they are willing to be (putting aside their egos if they make a bad call), the longer economic expansions can run. Thus far Powell’s Fed appears to be flexible, and flexibility in the face of changing data will be critical as the Fed attempts to navigate the economy through a slow growth global environment with a balance sheet of unprecedented size.

Be well,