Strategy Update

April 29, 2019

Dow Jones Average: 26,543
S&P 500 Index: 2,940


Financial Fears Abate

Markets around the world advanced to begin the year. All of the concerns that consumed
investors at the end of 2018 were gradually put to rest. With fears proving overblown,
markets were poised for a significant recovery. The Standard & Poors 500 Index recovered
13.6% in the first quarter, nearly erasing the losses incurred in the previous quarter. European
stocks matched that advance, and Chinese stocks rose even further. The price of bonds also
rose around the world as interest rates fell once again.
There were two narratives that scared investors in the fourth quarter of 2018. The
rhetoric surrounding the trade war had reached a boil by late fall. Some tariffs had already
been put in place during the year, but more were feared as the U.S. and China seemed
increasingly far apart on their respective demands. Equally consequential was the persistent
rise in interest rates engineered by the Federal Reserve. The Fed felt that such a policy was
necessary to ward off any incipient inflation and to normalize interest rates after a decade of
abnormally low rates. The Fed signalled that further rate increases were planned for 2019,
which troubled investors. Politicians and central bankers felt comfortable pushing their
trade war and interest rate agendas in the autumn of 2018, given the strength of the economy
and resiliency of markets. But when the stock market plunge accelerated in December and
economic data began to deteriorate, the politicians and bankers blinked.
Policy direction on trade and on interest rates have turned 180 degrees from last fall.
Witnessing the damaging effects of their trade war, particularly on the Chinese economy,
trade representatives in the United States and China softened their tone. No final outcome
has yet been reached, but the most damaging tariffs have been postponed and it is clear that
both sides are more committed to finding a resolution. Perhaps even more important than
that ceasefire has been the change in guidance from the Federal Reserve. Amid signs of
market turmoil and a softening economy, the Fed has abandoned its plan to continue raising
interest rates. Many investors have started to assume that the Fed may fully shift gears and
start to lower interest rates once more. To get ahead of such a move, investors have piled
into longer-dated bonds, lowering yields in the process. As yields have fallen on treasury
bonds, nearly every other asset has become more attractive to investors, from dividend
paying stocks to junk bonds and everything in between. It is this rather simple relationship
between treasury bonds and all other asset classes that has underpinned the global recovery
across many markets in 2019.

Current Strategy

Stock and bond markets have recovered to begin the year because investors’ worst fears
were not realized. The advance has been broad and has included most sectors of the
market. Riskier assets have recovered significantly, in part because their decline last year
was so steep. Additionally, shares of some safer, dividend-paying companies have rallied,
in part because their dividends look more attractive relative to lower bond yields.
Shares in most of our investment selections have advanced alongside the market,
including the new positions we bought for clients late last year and early this year during
the decline.
We believe that for markets to continue marching higher investors will require a
benign economic climate and meaningful profit expansion. The change in Fed policy
and lessening of trade tensions was enough to ignite a rally, but it will take more positive
news on profits to keep it going. It may be difficult to squeeze more profitability out of an
aging economic expansion that has already benefited from massive amounts of fiscal and
monetary stimulus. We are dubious about a further rally in stocks, and have begun selling
or reducing some of our clients’ stock holdings.
We have left our bond strategy unchanged from before. With the ongoing narrowness
of the bond curve, meaning that short-term and long-term bonds presently pay out nearly
the same level of income, we are reinvesting cash from maturing bonds into short-term
bonds. In our view, this provides clients with the greatest combination of income and
flexibility as we move forward.
We also want to mention that our Brattleboro headquarters is once again situated in
our “old” location at 950 Western Avenue in Brattleboro. We rented this historic house for
over ten years in the 1996-2007 period and last fall decided to buy the building outright.
It needed a lot of work, which included roof repair, floor sanding, and a thorough painting
inside and out. That has all been accomplished, and we are very pleased to call it home
once again. Please note the change in address to:

Prentiss Smith & Co.
950 Western Avenue
Brattleboro, Vermont 05301