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PGAM First Quarter 2019 Investor Letter

April 10, 2019

Global equity markets rebounded strongly during the first quarter of 2019 reversing most of the losses of the prior quarter. The recovery in share prices was accompanied by a decline in volatility, which returned close to levels seen in the first three quarters of 2018. The U.S. stock market benefitted from a shift toward a more accommodative monetary policy by the Federal Reserve. In early January, the Fed announced a pause in its multi-year raising of short-term interest rates which eased heightened concerns over the risk of a recession from monetary policy error. Accommodative monetary policies in Europe and Japan and efforts by China to stimulate economic growth also had a favorable impact on share prices globally. Below is a summary of performance of various equity market indices which show the U.S. equity market outperforming over all time periods indicated:

Trends in the global economy are mixed, with steady growth in the U.S. contrasting with marked economic slowdowns in Europe and Japan. A slowdown in the Chinese economy is a major factor in the weakness in the European and Japanese economies, which are heavily dependent on exports to China. However, China is undertaking an effort to stimulate its economy. Measures include increased debt issuance, higher spending on infrastructure projects, and a value added tax relief program. These efforts are beginning to have a positive impact, as reflected in the latest Chinese Purchasing Managers Survey which rose to above 50, reflecting an expanding economy. Emerging markets business activity now exceeds the developed markets:

An improving Chinese economy should lead to increased business activity in international developed markets.

Evidence of progress in trade negotiations between the U.S. and China are also leading to a brighter global economic outlook, although the final outcome remains uncertain.

In the U.S. a strong employment picture and high levels of consumer confidence remain positive catalysts for the economy as a whole. In the payroll report issued on April 5, payroll gains increased to 196,000 during March after a modest increase of 33,000 in February, while hourly wage gains slowed to 3.2% year-on-year vs. 3.4% the previous month. This report should reinforce the Federal Reserve’s decision not to increase interest rates further for the foreseeable future. This should enhance the prospects for a continuation of steady economic growth and provide support for the achievability of corporate earnings growth in 2019.

Equity Strategy

Our outlook for global economic expansion leads us to remain positive for the upside potential in equities over the coming quarters, even after the strength exhibited so far in 2019. Investor sentiment (e.g. the Fear & Greed Index) has improved rapidly, but the sentiment of large institutional investment managers remains cautious. We maintain a balance between procyclical and growth sectors of global stock markets with an underweight in higher yielding “bond proxy” sectors. We continue to maintain a significant commitment to the sectors of Technology, Communications Services, and Health Care focusing on companies with durable earnings growth outlooks. The procyclical areas which should benefit from global growth and where we continue to see very attractive valuations include Diversified Financials, Energy, and Semiconductors.

We have focused on key investment themes across all our portfolios driven by long-term global economic trends and demographics. Among these are technological innovation, including the advancements of cloud computing, artificial intelligence, and 5G. Consumer tastes are evolving due to emerging market wealth creation, consumers valuing experiences over things, and value consciousness. We anticipate interest rate normalization, which will benefit selected stocks including banks and companies with “fortress” balance sheets. Medical therapies, services, and equipment are industries well positioned to take advantage of aging population trends worldwide. Another theme is global energy transformation, which includes companies with North American production, logistics, and clean fuels. A final theme is aerospace and defense, reflecting significant increases in global travel and increased defense spending.

In our Global Equity Strategy, we remain confident in our increased commitment to Emerging Markets. Improving prospects for China and for the global economy as a whole should lead to further gains in emerging market shares. These markets remain extremely undervalued based on favorable longer-term potential. We believe the historically large differential in performance compared to U.S. equities should gradually narrow in the years ahead. While European equities remain undervalued on a historical basis, we remain underweight as potential for monetary stimulus is limited with zero to negative interest rates across major markets. Potential for stimulus in Japan is better defined reflecting improvement in corporate governance, so we retain meaningful exposure to the Japanese equity market. We continue to recommend global equity exposure – U.S. performance vs. International is cyclical:

Within our Dividend Growth Strategy, we have been selectively replacing our exposure to economically sensitive holdings and increasing our exposure to companies we perceive as quality long-term compounders trading at reasonable valuations. This includes new positions within the Technology Services, Medical Devices, and Entertainment industries. Companies that generate healthy free cash flow with above market dividend growth historically perform well over long-term market cycles. Updated data from Ned Davis Research on “Dividend Growers” supports this belief:

Fixed Income Strategy

U.S. interest rates in the 2 to 10-year maturity range continued to decline during the first quarter of 2019. At the end of the first quarter of 2019, the yield on 2-year Treasury obligations was 2.26% versus 2.48% as of year-end 2018. Over the same time period, the yield on 5-year Treasuries declined from 2.51% to 2.23% while the yield on 10-year obligations declined from 2.68% to 2.41%, For a brief period, yields on 10-year obligations were below those on three month Treasury Bills, but that condition reversed quickly.

A major portion of the decline in U.S. yields reflected a shifting of funds from Europe, where German yields became negative. Also, lower yields resulted in a decline in mortgage rates and large institutional holders purchased Treasuries in the 2 to the 7-year range as a hedge. We expect these trends to reverse in coming months as the Federal Reserve refrains from raising short term rates while a more optimistic assessment of U.S. economic growth prospects enables longer-term interest rates to rise toward levels seen earlier in 2018.  Given this outlook, we adhere to a strategy of maintaining shorter than average durations in our taxable and tax-exempt fixed income accounts and a focus on U.S. Treasury and high-quality corporate obligations. This approach should optimize the balance between current yield and risk.

As always, we are available to discuss any investment or financial matters with you. Our highest priority is to ensure that you have the portfolio asset allocation which is appropriate for your individual requirements and preferences while remaining patient and focused on the longer term.

 

Sincerely,

Princeton Global Asset Management LLC

 

Important Disclosures:
This report is for informational purposes only and contains data based on information Princeton Global Asset Management (PGAM) believed to be accurate. However, PGAM cannot assure the accuracy of the data.  Past performance is not a guarantee of future results. Portfolio holdings and characteristics are subject to change. The information in this report should not be considered a recommendation to purchase or sell any particular security.  It should not be assumed that any of these securities transactions or holdings that may be cited were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of securities cited.

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