Quarterly Update

Oct. 2019

Matthew Peron, Chief Investment Officer, Senior Managing Director | Oct. 2019

Modest Gains, More Volatility Mark Late-Cycle Investing

Though most financial markets advanced modestly in the third quarter, the climb higher was jarring at times, with sentiment flipping quickly between risk-on and risk-off.

While fundamentals on the whole look reasonably healthy, the business cycle is aging, growing more vulnerable to policy missteps and other shocks.

Fed rate cuts and prospects for continued U.S. economic growth have helped produce strong gains in equities, with the S&P 500 index up 20.6%.

This is what late-cycle investing looks like: more modest gains, harder fought with higher volatility, as investors grapple with mixed messages about the sustainability of the expansion.

Of all the factors underlying market turbulence, the trade war continues to cast the longest shadow.

The longer the trade conflict remains unresolved, the more it will damage the global economy and corporate profits.

We are approaching the end of a very long economic and market cycle, which means the easy money has already been made.

Those looking for a quiet summer didn’t get it. Though most financial markets advanced modestly in the third quarter, the climb higher was jarring at times, with sentiment flipping quickly between risk-on and risk-off. In August alone, we experienced 11 days with market moves of 1% or more as slowing global economic growth, broader political uncertainty, and falling and even negative interest rates all took turns drawing investor attention.

In many ways, these concerns aren’t new. Worries over the pace of economic growth and uncertainty around policy have been with us ever since the global financial crisis ended, causing periodic bouts of market and interest rate volatility. But lately things have started to feel more concerning. While fundamentals on the whole look reasonably healthy, the business cycle is aging, growing more vulnerable to policy missteps and other shocks.

It has been a good year for U.S. investors. The global economic slowdown and geopolitical turmoil have created a run toward safe assets, as reflected by the 6.3% YTD increase in the Barclays Global Aggregate Bond Index. At the same time, Fed rate cuts and prospects for continued U.S. economic growth have helped produce strong gains in equities, with the S&P 500 index up 20.6%. However, stepping back our perspective, we see that the stock market ended the third quarter having made only limited headway (+3.7% price increase) since it hit its January 2018 high.

This is what late-cycle investing looks like: more modest gains, harder fought with higher volatility, as investors grapple with mixed messages about the sustainability of the expansion. Moving forward, we expect economic growth will remain challenged and interest rates depressed for some time. While that doesn’t mean the potential for further market gains is over, it does mean investors should expect lower returns across asset classes than they enjoyed over the last few years.

Of all the factors underlying market turbulence, the trade war continues to cast the longest shadow. Twice before over this expansion, we’ve experienced cyclical downturns in the global economy, yet this current episode has the potential to be more enduring and threatening. Uncertainty about the extent and longevity of trade disputes has dampened not just trade, but sentiment and related expenditures, such as new investment and job hiring. The longer the trade conflict remains unresolved, the more it will damage the global economy and corporate profits.

The big question, though, is whether this weakness will spread to the much larger services sector, which for the most part held up well against the previous downturns in manufacturing seen this cycle. Indeed, until recently, the case could be made that the broader economy would be generally immune to concerns about global trade conflict. However, the latest data on confidence, consumption and household employment have shown potential early signs that may be changing, a risk not lost on financial market participants.

Despite these worries, we don’t see a recession in the immediate future. The usual suspects are missing. The household sector remains in generally good shape with unemployment at a 50-year low, inflation pressures are modest, and there are few signs of excess in the economy. Global financial conditions have also eased significantly over the past four months, which usually bodes well for global growth and equity prices, thanks in part to the dovish pivot by most central banks.

All this suggests moderate risk taking will likely continue to be rewarded in coming quarters — even as recent developments reinforce our decision to focus on greater portfolio resilience (see table). We are approaching the end of a very long economic and market cycle, which means the easy money has already been made. From here, investors will have to construct portfolios with increasing care. We still believe maintaining a portfolio of high-quality, durable assets will beat a bond or cash portfolio in the months ahead, so we want to stay invested to earn our yield and growth. But as the cycle matures and risks rise, we will continue to take steps to protect our clients’ capital.

Key Points

Though most financial markets advanced modestly in the third quarter, the climb higher was jarring at times, with sentiment flipping quickly between risk-on and risk-off.

While fundamentals on the whole look reasonably healthy, the business cycle is aging, growing more vulnerable to policy missteps and other shocks.

Fed rate cuts and prospects for continued U.S. economic growth have helped produce strong gains in equities, with the S&P 500 index up 20.6%.

This is what late-cycle investing looks like: more modest gains, harder fought with higher volatility, as investors grapple with mixed messages about the sustainability of the expansion.

Of all the factors underlying market turbulence, the trade war continues to cast the longest shadow.

The longer the trade conflict remains unresolved, the more it will damage the global economy and corporate profits.

We are approaching the end of a very long economic and market cycle, which means the easy money has already been made.

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Important Disclosures

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and, although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as of the date of this document and are subject to change.

Concentrating assets in a particular industry, sector of the economy, or markets may increase volatility because the investment will be more susceptible to the impact of market, economic, regulatory, and other factors affecting that industry or sector compared with a more broadly diversified asset allocation.

Private investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information.

Alternative investments are speculative, entail substantial risks, offer limited or no liquidity, and are not suitable for all investors. These investments have limited transparency to the funds’ investments and may involve leverage which magnifies both losses and gains, including the risk of loss of the entire investment. Alternative investments have varying and lengthy lockup provisions. Please see the Offering Memorandum for more complete information regarding the Fund’s investment objectives, risks, fees, and other expenses.

There are inherent risks with equity investing. These risks include, but are not limited to, stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices. Investing in international markets carries risks such as currency fluctuation, regulatory risks, and economic and political instability. Emerging markets involve heightened risks related to the same factors, as well as increased volatility, lower trading volume, and less liquidity. Emerging markets can have greater custodial and operational risks and less developed legal and accounting systems than developed markets.

There are inherent risks with fixed-income investing. These risks may include interest rate, call, credit, market, inflation, government policy, liquidity, or junk bond. When interest rates rise, bond prices fall. This risk is heightened with investments in longer-duration fixed-income securities and during periods when prevailing interest rates are low or negative. The yields and market values of municipal securities may be more affected by changes in tax rates and policies than similar income-bearing taxable securities. Certain investors’ incomes may be subject to the Federal Alternative Minimum Tax (AMT), and taxable gains are also possible. Investments in below-investment-grade debt securities, which are usually called “high yield” or “junk bonds,” are typically in weaker financial health and such securities can be harder to value and sell, and their prices can be more volatile than more highly rated securities. While these securities generally have higher rates of interest, they also involve greater risk of default than do securities of a higher-quality rating.

All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.

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