In Client Letters

Followers of the stock market over the past two quarters may be of the opinion that it is in a state of utter confusion or disorder…the Merriam-Webster’s definition of topsy-turvy.  During the 4th quarter of 2018, US stocks (S&P 500 Index) had an intra-quarter loss of nearly 20% and a full-quarter loss of more than 13%.  During the 1st quarter of 2019, the US stock market delivered its best quarter since 2009 and its largest first-quarter gain since 1998, rising over 13%.  As crazy as that may seem, investors know that the stock market is famously volatile and that the best approach is not to follow speculative short-term trading strategies, but to take a very long-term view by investing in sustainable businesses.

What is far stranger is the fact that 29% of global government bonds have traded at negative yields so far in 2019.  If investors buy bonds with a negative yield, they are essentially willing to pay the governments to keep their money safe…talk about topsy-turvy!  Europe and Japan, regions with the most dire economic outlooks, have the highest percentage of their government bonds trading at a negative yield.  Investors who are seeking positive returns are forced to buy into more risky areas of the market, such as high yield (“junk”) bonds, emerging markets debt, or stocks.  Conservative investors around the globe have purchased long-term US Treasury bonds, which is pushing US interest rates lower.  In the meantime, the US Federal Reserve Bank has been pushing up short-term interest rates in an effort to combat inflation.  This confluence of events led to a partial, and temporary, “inverted yield curve” in the US bond market during the quarter, meaning that the yield on 10-year Treasury bonds fell below the yield for 3-month Treasury bills…more topsy-turvy.

Much has been written about the predictive nature of an inverted yield curve signaling an impending economic recession.  In fact, an inverted yield curve has preceded 7 of the past 9 recessions, with an average lag of about 14 months.It is important to remember that an inverted yield curve does not cause a recession, but rather is indicative of conditions that may lead to a recession.  A major difference between the current yield curve (which, by the way, is no longer inverted but very flat…indicative of uncertain economic conditions) and past inversions is that current absolute yields are historically low.

So, while this topsy-turvy bond environment has spooked many investors, it is not certain that it will predict the next recession.  In the meantime, hold on to your hats!3

2019 Q1 Market Review

During the quarter, all broad stock market indexes experienced an incredible rebound.  Small cap stocks gained slightly more than large cap stocks and growth stocks regained their edge over value stocks.   Every sector in the US stock market delivered strong returns.  The best performing sectors in the S&P 500 Index in Q1 included Technology (+19.9%), Industrials (+17.2%) and Energy (+16.4%)…a mirror image of last quarter!  The “worst” performing sectors during the quarter included Health Care (+6.6%), Financials (+8.6%) and Materials (+10.3%).

Non-US developed and emerging markets stocks also rebounded during the quarter.  The best performing countries included China (+17.7%), Russia (+12.2%), and the UK (+11.9%).  Japan (+6.8%), Germany (+7.0%) and India (+7.2%) generated solid but less spectacular returns. The US Dollar was mixed relative to other currencies in Q1.

US fixed income markets again generated positive returns in Q1, given the new expectation that the Fed will not raise rates in 2019.   The corporate and high yield sectors led the way during the quarter, while cash yields flattened a bit.

Here are the returns for select market indices for Q1 (as stated in US Dollars):

Responsible Investment Corner

The Global Sustainable Investment Alliance (GSIA) just released it biennial Global Sustainable Investment Review 2018, which pulls together data from regional investment forums from Australia/New Zealand, Canada, Europe, Japan and the United States.  The report also includes data on the African sustainable investing market, as well as several countries in Central and South America.  At the start of 2018, global sustainable investment assets grew by 34% from 2016, to $30.7 trillion!  Growth in sustainable investing has occurred in all regions surveyed.  Europe has the largest concentration of sustainable investment assets at $14.1 trillion, followed by the US at $12 trillion.  Japan saw the greatest percentage increase in sustainable investment assets and the Australia/New Zealand region has the highest proportion of total investment assets being managed sustainably at 63%.

There are various methods of sustainable investing.  Negative screening is the largest strategy in Europe, while Environmental, Social and Governance (ESG) integration dominates in the US, Canada and Australasia.  Corporate engagement/shareholder action is the dominant strategy in Japan.  Impact investing (capital aimed at solving social or environmental problems) is a small, but growing and vibrant segment of the sustainable investment universe.4

Here’s an example of the impact that can be made through corporate engagement, as described by one of the SRI funds held by some of our clients:  “McDonald’s made its meals happier this week by announcing the formal adoption of a policy to restrict medically important antibiotic use in its beef supply chain.  McDonald’s will begin by monitoring antibiotic use in its top ten beef sourcing markets across the globe and use that data to set reduction targets for medically important antibiotic use by the end of 2020.”  This announcement is a result of the efforts of many responsible investors, collaborating with non-partisan public interest groups.  Other examples of McDonald’s renewed view of corporate responsibility include:

  • Becoming the first global restaurant company to set a Science Based Target to reduce its greenhouse gas emissions in line with the recommendations of the Paris Climate Agreement.
  • Declaring its intention to achieve a company-wide no deforestation commitment, covering all supply chains, by 2030.
  • Set a goal for all packaging to be 100% renewable, recycled, or certified sustainable by 2025.5

An example of direct impact investing is described by an organic farming REIT, which financed the purchase of a 120-acre parcel of farmland in Iowa for a family that had rented the land for 30 years.  This farming family grows organic corn, soybeans, oats, alfalfa hay, milling wheat, spelt, rye, buckwheat, open-pollinating milling corn, and dry edible beans.  They specialize in milling grains for sale to local restaurants and bakeries.6

From organic farming to green bonds to impact loans to engaged equity funds, there are numerous investment opportunities available to investors that can achieve the “triple bottom line” of positive financial returns, social responsibility and environmental impact.  You can learn more via our weekly blog posts.

This and That

  • While recession odds have risen over the past several months, Moody’s Analytics has placed the odds of recession in the next 12 months, based solely on economic data, at 21%.  Financial market data would imply that the odds of a recession in the next 12 months are 36%.7
  • Global water demands could exceed supply by 40% by 2030.  One in nine people, 783 million across the world, currently lack access to safe and clean drinking water.  The US loses 16% of daily water production to leaking pipes and it’s even more globally, including 53% in Delhi, India, 38% is Sao Paulo, Brazil, and 28% in London, UK.8
  • It is a great time to be a sports fan in Milwaukee!  The Bucks basketball team has secured the #1 overall seed in the upcoming NBA playoffs and the Brewers are off to another hot start after falling only one game short of the World Series last season.
  • “The stock market is filled with individuals who know the price of everything, but the value of nothing.” – Phillip Fisher

Thank you for being a client of Falcons Rock!

Gregory D. Wait, President
Falcons Rock Impact Investments, LLC

1 JPMorgan, Why are bond yields going negative again?, April 5, 2019
2 JPMorgan, Guide to the Markets, 2Q 2019, March 31, 2019
3 Another definition of topsy-turvy is “with the top or head downward,” Merriam-Webster’s Dictionary
4 GSIA press release, April 1, 2019
5 Green Century Funds press release, December 13, 2018.
References to specific securities should not be construed as an investment recommendation by the funds, or Falcons Rock.

6 Iroquois Valley Farmland REIT, Our 12th Harvest, December 20, 2018
7 Moody’s Analytics, Economic Roundup, April 2, 2019
8 AllianzGI Global Water Fund Fact Sheet, 4Q 2018