First quarter equity results were solid and, ironically, seem to have prompted a new round of questioning as to “how long can the good market continue?” Often, good results create confidence and a bit of euphoria, so when good returns beget skepticism, it is noteworthy.
From our perspective the market is currently in the late stages of this economic expansion. We have crossed into the uncharted territory of an 11th year of expansion. Previously, the longest expansions on record were 10 years and 8 years1. This does not mean a cyclical decline is imminent, even as we note the inversion of the yield curve in March. In broad terms, historically recessions follow inversions, on average, in 14 months2. The message is that in this late cycle phase, risk management is just as important to our strategy as investing for opportunity.
We continue to have a constructive outlook for 2019. We expect ongoing economic expansion, positive growth in earnings, and valuations are in a range that we would call fairly priced. We have been making adjustments within our portfolios, deemphasizing the more economically sensitive sectors (Industrials, Financials, Energy and Materials) and giving incrementally more emphasis to less economically sensitive sectors (Healthcare, Consumer Staples and Utilities). The intent is better risk management by accentuating defensive characteristics. When the data turns and we perceive that the risks of an economic contraction are more pronounced, we will shift into an even more defensive posture. Any such adjustment would be data driven — cyclical risk management is not about forecasting or swings in sentiment.
Over the last 60 years, the U.S. market has had six declines of 25% of more3 and five of those were during recessions. When asked what we think will be the catalyst for the next recession, we believe a single variable explanation as THE catalyst is the kind of clarity that only comes with hindsight. For the Tech Crash or the Financial Crisis, neither was reduce-able in the moment to a single theme. On the contrary, when those events occurred they were complex and confusing, and the list of issues extended well beyond Tech and Financials. Thematic clarity most often must wait for the postmortem. In employing a risk management strategy, it is most important to focus on the data.
We have been very satisfied that our fixed income strategies have defended so well during a period when the bond market has gone on its own roller-coaster ride. We allocate to the asset class to reduce risk, and our short maturities and good credits have delivered successful results.
Our Quality at a Reasonable Price investment discipline has contributed to delivering solid results with less valuation risk. The importance of getting quality and valuations right is even more significant in the late cycle. Our performance objective is better results via better risk management over the cycle.
We expect this strategy will provide a competitive advantage over both the short and long-term. The late cycle phase is not the time for business as usual. Rather, it exacerbates the need for independent, critical thinking.