The past twelve months have seen a marked increase in volatility, with Fed actions, recession fears, and tariffs sending markets from record highs to a bear market (20% decline) from September to December 2018. 2019 began with a massive rally which approached recent highs, followed by quick bouts of selling which neared 10% correction levels. In June 2019, the second downturn was reversed upon the news that the Fed is likely to lower interest rates (100% probability of a July cut priced in to futures market) and the postponing of tariffs on Mexico, along with restarting of trade talks with the Chinese. The S&P 500 hit a new record high this quarter end.

Within the context of major US averages hitting highs, most other asset classes trailed. First, the lower interest rate inspired outperformance of large US growth stocks began again, with growth valuations running back to near record spreads over value. Large stocks outperformed small stocks, and US outperformed international. Emerging markets underperformed developed markets as the global economic slowdown and tariff threats hurt them the most. Oil retreated as global demand ebbed. Once again, as has been the case for the past decade, any diversification away from large US growth stocks detracted from performance.

The bond market experienced an across the board rally in the new year, after a mild credit selloff ended 2018. Long duration government bonds have performed exceptionally, as the 10 year Treasury yield moved from 3.25% in October 2018 to 2% today. Many European government bonds are now trading at negative yields –investors have to pay governments, including Italy, for the custody of their assets!

Predictably, AFA’s well-diversified, value tilted portfolios have underperformed the large cap US indices. Our exposure to Asia and our value tilt, plus exposure to sectors which are influenced heavily by reactions to news about trade, have put us slightly behind the MSCI World index after leading it through the first 4 months of the year. Our bond performance has been very steadily positive with low volatility, but has trailed the Bloomberg/Barclay’s Aggregate in the past 2 months as the prices of riskier long duration high-grade bonds have spiked.

Observing market behavior, risk appetite is high and uncertainty is increasing. Here at AFA we see increasing volatility, an inverted yield curve, and a marked slowdown in global growth pointing to the likelihood of even more extreme market behavior.