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The $26 Billion Woman Posted in: Featured, People - Read the Washington Business Journal profile on Amy Raskin, Chief Investment Officer, at Chevy Chase Trust.

Amy was also recently featured on CNBC. View below:
Don’t just take our word for it. Posted in: Featured - At Chevy Chase Trust, we specialize in global research and thematic investing informed by careful planning, and it's working. Forbes and RIA Channel recently ranked us among the highest in their Top 100 list, for 2 years running. Important Disclosures
Chevy Chase Trust - Investment Update, Third Quarter 2018 Investment Update, Third Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index generated a total return of 7.71% for the third quarter, bringing the nine month return to 10.56%.
Other News
  • Food for Thought: When should I start taking Social Security benefits? Posted in: Noteworthy, People, Video - We receive a lot of questions about social security benefits and as food for thought, we are sharing the answers on when is the best time to collect.

    Think you should wait to start taking Social Security? At Chevy Chase Trust, many of our clients are asking this very question. Leslie Smith, Head of Planning, examines key decisions as you head into retirement—and what happens if you choose to wait.

  • Chevy Chase Trust hosts Health Insights 2018 Posted in: Events, Noteworthy - On October 3, Chevy Chase Trust hosted Health Insights 2018, a program featuring three experts in the areas of genetic testing, the microbiome and the mind-gut relationship.  

    On October 3, Chevy Chase Trust hosted Health Insights 2018, a program featuring three experts in the areas of genetic testing, the microbiome and the mind-gut relationship.

    The first session featured Beth Peshkin, Professor of Oncology and Director of Genetic Counseling at Georgetown Lombardi Comprehensive Cancer Center. Professor Peshkin discussed hereditary cancer testing, and the benefits of working with a genetic counselor.  Since 1998, the cost of genetic testing has significantly decreased, thereby opening access to a wider cross section of individuals.  This increased access is producing data that influences preventive care and helps doctors make informed decisions regarding future care. Peshkin pointed out that while in some cases, genetic testing may be life- saving, consumers need to be very careful about the tests they use as the quality and reliability of results vary greatly.

    The second session featured the co-founders and co-directors of the Amos Food, Body & Mind Center at Johns Hopkins. Glenn Treismann, MD, PhD, the Eugene Meyer III Professor of Psychiatry and Medicine at the Johns Hopkins University School of Medicine, and Director of the AIDS Psychiatry Service spoke about how genes and the bugs that make up our microbiome drive the choices we make every day.  His remarks were followed by those of Jay Pasricha, MBBS, MD, Director of the Johns Hopkins Center for Neurogastroenterology. Dr. Pasricha explained how increased knowledge of the microbiome/brain relationship is shaping patient treatment for an extensive number of disorders and diseases.  Describing the microbiome itself as a brain for the body, Pashricha indicated it controls us just as much as the brain in our heads. Both doctors predicted that in the future, medical treatment may be based on the food we eat rather than the medicines we take.  According to the doctors, diabetes and obesity are two conditions both successfully managed by the replacement of certain bugs in the microbiome.

  • “Less Cancer” is Paving the Road to Cancer Prevention Posted in: Community, Noteworthy - A 501c3 nonprofit public charity, Less Cancer focuses on addressing preventable cancers through education and continuing medical education for healthcare providers, including physicians, nurses and public health professionals. 

    Larry Fisher, President of Family Wealth Services for Chevy Chase Trust, is on the Board of Directors of Next Generation Choices Foundation, more widely known as Less Cancer. A 501c3 nonprofit public charity, Less Cancer focuses on addressing preventable cancers through education and continuing medical education for healthcare providers, including physicians, nurses and public health professionals. The organization has been an influential leader in policy is founders of National Cancer Prevention Day, the National Cancer Prevention Workshop, the United States Congressional Cancer Prevention Caucus.

    The organization’s flagship program, the National Cancer Prevention Workshop, is streamed live to a community of over 57,000 globally, providing continuing medical education at no cost to participants.

    The organization has instituted programming since 2004. Find out more about Less Cancer here:

    Ed Shoemaker at the Less Cancer Bike Ride













  • Pros, Cons to Buying Nvidia Stock - Chevy Chase Trust Pros, Cons to Buying Nvidia Stock Posted in: Insights, Noteworthy - As Nvidia makes deep inroads into AI, its share price is skyrocketing. Bobby Eubank, Equity Research Analyst weighs in.

    From U.S. News and World Report: Nvidia Corporation (Nasdaq: NVDA) has quite a story to tell and investors seem to be all ears these days — with good reason.

    Nvidia bills itself as a pioneer that has “supercharged” a form of computing loved by the most demanding and eclectic computer users in the world — scientists, designers, artists, and gamers. For them, NVDA has “built the equivalent of a time machine,” the company states on its website.

    “Nvidia has over $5 billion of net cash and investments on its balance sheet, despite having spent a cumulative $15 billion in R&D, funding numerous startups via its venture program, and is just completing a massive new state-of-the-art headquarters,” says Bobby Eubank, equity research analyst at Chevy Chase Trust. “Nvidia has done this by generating close to $3 billion in free cash flow last year via high revenue growth with nice margin expansion.”

    Of the $3 billion in free cash flow, $1.25 billion was used for dividends and stock repurchases, Eubank adds.

    To read the full article, click here.

    Important Disclosures

  • Chevy Chase Trust - Investment Update, Third Quarter 2018 Investment Update, Third Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index generated a total return of 7.71% for the third quarter, bringing the nine month return to 10.56%.

    Macroeconomic Outlook — The S&P 500 Index generated a total return of 7.71% for the third quarter, bringing the nine month return to 10.56%. It reached an all-time high of 2,931 on September 20th, before retreating slightly to end the quarter at 2,914. Global desynchronization continued with international markets underperforming the U.S. by a wide margin. The MSCI All Country World Index ex-U.S. generated a meager total return of 0.8% for the third quarter while the global composite index, of which U.S. stocks represent 52%, returned 4.40%.

    Two factors contributed to the relative strength of the U.S. market. Two years of fiscal stimulus in the form of tax cuts and government spending have helped corporate earnings. Second, there is a structural difference in the composition of the U.S. Index. Growth and non-cyclical stocks in the technology, consumer discretionary and healthcare sectors represent more than half of the S&P 500 Index. In contrast, most non-U.S. markets have heavier representation in cyclical and value oriented stocks in sectors such as materials and financials. 

    We have been in a relatively slow growth world which makes companies with strong top line momentum more valuable for their scarcity. More of these successful growth companies are domiciled in the U.S. than elsewhere. Valuation spreads between growth and value stocks began 2018 at near record levels and have only grown wider. Indeed, even beyond the U.S., the most expensive and least cyclical markets at the start of the year have performed best. The NASDAQ, the most expensive global market, is also the best performing. Japan, which we discuss below, is another expensive and positive performing market.


    The widening gap between growth and value has some parallels to the late 1990s/early 2000s period. That was the last time earnings expectations were this high and technology this large a percentage of the S&P 500.  However, while similar on the surface, there are differences. The betas of the most expensive stocks in the market are much lower today than two decades ago. If a stock has a beta of less than 1, the security is theoretically less volatile than the market as a whole. If a stock has a beta of more than 1, it is more volatile. Interestingly, in the late 1990s/early 2000s, expensive or high P/E stocks, which included technology stocks, had an average beta of 1.2, or 20% more volatile than the market. Today, this same group has a beta of 0.96, slightly less volatile than the overall market. Conversely, the beta of the lowest P/E stocks averaged 0.98 in the early 2000s and today are actually more volatile with a beta of 1.23.

    Technology has been the work horse of this bull market. Unlike the late 1990s and 2000s, technology companies are not being measured exclusively by clicks and eyeballs. Today, the technology sector is fundamentally sound in terms of exceptionally strong profit and cash flow generation. The chart below shows the impact of improving technology profit margins on the overall equity market for the better part of a decade. Without technology, the operating margin for the S&P would be significantly lower. Naturally, increasing profits must underpin the parabolic rise in margins. Since 2006, technology’s earnings per share has almost quadrupled, pulling overall S&P profits higher. 





    In our view, the profit outlook for the technology sector remains bright, driven to a large extent by capital expenditures. Technology continues to make inroads in the overall capex pie, and now has doubled its share since the 2008/2009 financial crisis to roughly 12%. Technology new orders-to-inventories are also picking up and suggest that market analysts are underestimating relative earnings per share growth. Finally, consumer outlays on tech goods are increasing faster than overall consumer spending. Nevertheless, we have moderated our technology sector overweight due to extremely strong relative performance of our core tech holdings, but they remain some of our highest conviction thematic holdings.


    What’s Depressing Growth? 

    While demographics are weighing on global growth, in our opinion high levels of debt are also a major contributor to slower growth. The real rate of GDP growth when debt levels are high has historically been half the rate of that when debt levels are low.

    Debt represents consumption today at the expense of consumption in the future. Excessive debt is a burden on growth unless it is used for productive investment. Unfortunately, it appears much of the recent incremental debt has been used for consumption.

    Within the U.S., from an aggregate perspective, total nonfinancial debt-to-GDP has remained largely stable since the 2008/2009 financial crisis. But there has been a distinct change in attitudes toward debt – households have deleveraged with the ratio of consumer debt to income down from 130% to 100%. However, public sector debt has more than offset the slowdown in consumer borrowing. 



    There is a catch-22 aspect in this. If more robust economic growth leads to a normalization of interest rates, debt service could soar which would then likely put the economy back in a very slow growth environment. Since the Fed started raising the federal funds rate at the end of 2015, net interest paid by the U.S. Government rose from $225.5 billion during the 12 months of 2015 to a record high of $320.3 billion for the 12 months ended August 2018. Over this same period, publicly-held U.S. Treasury bonds jumped $2.1 trillion to a record $15.8 trillion. If the Fed succeeds in gradually normalizing monetary policy and the federal funds rate rises to 3.00% by the end of 2019, the current amount of debt outstanding would push the government’s interest expense to over $500 billion annually by 2020. 

    It is difficult to predict when debt and deficit levels will weigh on markets. However, if interest rates start to rise above a neutral rate as a result of excessive debt levels, equity and fixed income markets will likely suffer.



    In a year marked by ex-U.S. global equity weakness, Japan is one market that continues to stand out with the Nikkei breaking out to seven-month highs in September. 

    The Bank of Japan recently reaffirmed its intention to keep interest rates low indefinitely. Shinzo Abe was re-elected in late September and will become the country’s longest-serving prime minister with a term running to 2021. Corporate profitability is at a record high, yet foreign investors have pulled more than $40 billion out of Japanese equities, masking some of the market’s strength. 

    The Japanese economy is showing the strongest signs yet of breaking out of its deflationary funk. Unfavorable demographics is often blamed for all that ails Asia’s second largest economy. But recent tightness in the labor market has led to a rise in the participation rate. Even with a larger labor force, demand for workers remains unmet and wage gains are now becoming more broad-based. If sustained, this rise in workers’ pay should lead to stronger consumer spending.

    Japanese companies appear able to absorb the increased cost of labor. Across a swathe of sectors, profit margins have risen to record highs as an undervalued yen boosts competitiveness. As long as labor productivity improvements keep pace with the rise in wages, profit margins are unlikely to come under undue pressure. And while changes in productivity are notoriously hard to measure, the renewed willingness of Japanese companies to invest in the domestic economy suggests productivity growth will likely continue.

    After the U.S., Japan is our largest portfolio weighting. As the gap between economic momentum in the U.S. and the rest of the world narrows, we may increase our weighting in Japanese companies, as many are also leading participants in our themes.



    Genomics and the advent of molecular medicine is one of our high conviction investment themes. This year the one millionth whole genome sequence was completed. The cost of sequencing the genome dropped below $1,000. Applications were filed with the FDA to begin trials of treatments using a gene editing technique called CRISPR. Scientists have identified more than five million genetic mutations with links to cancer. All of these developments give us confidence in the investment thesis.

    From an investment perspective, not only is the market for genomic sequencers growing at an accelerating rate, but the machines in service are also being more fully utilized. We estimate that the market for genome sequencing equipment is growing about 10% per year.  The market for consumables, which are the materials used with each run of a sequencer, is growing about three times faster. This is important because the genomic equipment sector follows the “razor/razor blade” model. Once a lab or a hospital buys a machine, they have to purchase consumables to run the machine. Similar to the shaving paradigm, over a lifetime of use, the recurring revenue from the consumables is likely to exceed the cost of the initial equipment. According to Illumina’s most recent reports, during 2018 customers will purchase an average of approximately $900,000 of consumables for each of its new NovaSeq sequencers. This exceeds initial company estimates of $730,000. Current forecasts are for the amount to rise to $1.5 million by 2021.

    As more diagnostics, and ultimately treatments, rely on understanding specific genetic sequences, we expect the market for sequencing equipment, and more important, the recurring revenue from higher margin consumable sales to grow rapidly. Beyond the equipment and supply manufacturers, we are researching and investing in companies that are developing never-before possible therapies for previously hard to treat or untreatable diseases.


    Fixed Income

    The 10-year U.S. bond yield continued to fluctuate in a relatively narrow range during the third quarter. It reached a low of 2.81% on August 24 and a high of 3.10% on September 25. Yields ended the quarter at 3.06%. 

    As expected, the Federal Reserve again raised the fed funds rate during the quarter by 25 basis points (0.25%).  Since the long end of the yield curve did not rise by a commensurate amount, the slope of the curve flattened. In fact, on August 27, the difference between the yields on 10-year Treasury bonds and 2-year Treasury bonds hit an intraday cycle low of 18 basis points. Unlike an inverted yield curve, a flat curve is not necessarily a sign of impending recession, but it is a signal that the Federal Reserve may not be able to raise rates much more before tightening slows economic growth. 

    Long-term bond yields are still far short of the 3.50% to 3.75% levels many were forecasting at the beginning of the year. We think yields will advance slowly in the near to intermediate term before falling back below 3.00% when the cycle inevitably turns.

  • What will it take to attract the next generation of advisers to the private wealth business - Chevy Chase Trust - Noteworthy What will it take to attract the next generation of advisers to the private wealth business? Posted in: Noteworthy, People - From Real Assets Adviser: The private wealth business is facing a persistent and decades-old personnel crisis. Marc Wishkoff, Managing Director, weighs in on what will it take to attract the next generation of advisers.

    From Real Assets Adviser: The private wealth business is facing a persistent and decades-old personnel crisis. The number of financial advisers continues to dwindle as RIAs struggle to attract young talent to the business. U.S. financial advisers number roughly 285,000, down from about 500,000 in the mid-1990s. The average age of a financial adviser is 51, and 38 percent of advisers are expecting to retire in the next 10 years, according to a report from Cerulli Associates. Only 10 percent of financial advisers are less than 35 years of age.

    What do RIAs need to do to reverse the trend? We asked a dozen leaders in the private wealth profession to offer their observations.

    Marc Wishkoff, Managing Director, “We believe the next generation of advisers will seek organizations where they can take pride in the collective achievement of the firm and a differentiated service model. Successful firms will emphasize attracting people who want to be a part of something, in contrast to those who simply aggregate assets, outsource investments, build a personal book of business and guard its portability. Providing talented advisers with an environment to focus on their chosen area of expertise — whether it be investment, planning or fiduciary work — will instill a culture that attracts ever more talent and shared success.”

    To read the full article, click here.

  • Should You Move to a Retirement Community Before Retiring - Chevy Chase Trust - Noteworthy Should You Move to a Retirement Community Before Retiring? Posted in: Noteworthy, People - From U.S. News & World Report: While many people relocate to retirement communities after they leave the workforce, some Americans are moving to one before stepping away from the office. Laly Kassa, Managing Director weighs in.

    If you’re thinking of settling in a retirement community while still in your working years, there are numerous financial advantages, as well as a few disadvantages, to be aware of. Follow these steps before moving to a senior living community prior to retiring.

    Check your current bills. If you live in an older, large home that requires an ample amount of upkeep, you might find it more expensive to stay in it while working. Upcoming repairs, such as replacing the roof or fixing the main floor, could translate to high future investments. “If home maintenance costs are high and keeping up with the house bills is getting you down, it may be time to sell your primary residence and move sooner rather than later,” says Laly Kassa, managing director of Chevy Chase Trust in Bethesda, Maryland.

    Read the full article here.
    Download the article here.
  • Amy Raskin featured on CNBC’s Fast Money Halftime Report Posted in: Noteworthy, Video - Amy Raskin, Chief Investment Officer, appeared on CNBC's Fast Money Halftime Report on August 28, 2018 to discuss current market conditions and what they mean for investors.

    Is today’s positive vibe on the economy based on sentiment or fact? Amy Raskin, Chief Investment Officer at Chevy Chase Trust, recently discussed market conditions and what they mean for investors on CNBC’s Fast Money Halftime Report. She also shared three stocks that have her attention.
  • Q & A with Ed Dobranetski Posted in: Noteworthy, People - We recently sat down with Ed Dobranetski, a Managing Director at Chevy Chase Trust, to learn more about his background and how he became interested in investment management.

    We recently sat down with Ed Dobranetski, a Managing Director at Chevy Chase Trust, to learn more about his background and how he became interested in investment management.


    What was your first job out of college?

    My career started near the trough of a business cycle, so securing anythingto do with financial markets was important to me.  I started as a broker, purely in sales, so I could take the Series 7 exam and have something to differentiate myself. I did various other odd jobs that young people do while they seek opportunities.  I washed windows at the Watergate once, for example.


    How did you become interested in investment management?

    Beginning college as a Political Science major, I changed to Business after a friend convinced me to compete in a national investment challenge game for college students.  Other students from my school won by a large margin, so I sought them out to learn what they did.  Consequently, I learned everything I could about Options trading that summer and earned all my spending money for the rest of my college days from a few hundred dollars.  The next semester I took a class in Futures and Commodities Trading, and passed the appropriate registration exam over winter break.  The following semester I started a “Hedge Fund” in the dorm.  It was a rollercoaster ride, but fun.  In the end, we only had enough for a very small cocktail party.


    What do you enjoy most about your career?

    What I enjoy most is working in the financial markets, and with clients. It is one of the world’s great laboratories for studying strategy.  Every day the landscape changes in some way.


    What is the most important lesson you learned from a mentor?

    I learned to manage with sincerity.  Most of our clients are experts in a field other than investment management.  In most cases, all of their savings are in our hands, and they trust us with the latitude appropriate for an expert. Trust and loyalty are a two way street; we both have obligations in the relationship.

    And also: “If something said in ten words can be said in five; use five words.”  I am still working on that one.


    What would you do if not this? Otherwise, I probably would have had a military career, who knows?  I have never considered anything else.


    What is your favorite place to visit/vacation?

    Fifteen years ago, I heard one of my favorite economist/strategists speak about investing in China when it was still very, very early in evolving.  He said: “you can’t sit here in your fancy country club and buy ETFs – you have to go there.”  I have probably been to Asia fifteen times since, and plan to retire there. We would go to Japan every year, but the dynamic stillness is too intense.


    What advice would you give to someone considering a path similar to yours?

    We are asked that question a lot. Getting paid to pick stocks is a desirable career, but it’s more than that. I am still learning.  It has been almost thirty years in the same industry; if I make it to fifty, I may have it figured out.  My advice: Empty your cup and find a good teacher to work for; that is the most important thing.


    Continue to Ed Dobranetski’s biography

  • Chevy Chase Trust - Investment Update, Third Quarter 2018 Investment Update, Second Quarter 2018 Posted in: Investment Update, Noteworthy - The S&P 500 Index began 2018 with an initial surge from 2,674 to a high of 2,873 on January 26th.

    Equity Market Performance  — The S&P 500 Index began 2018 with an initial surge from 2,674 to a high of 2,873 on January 26th. It then quickly and sharply pulled back to a low of 2,533 on February 9th. Since then the Index has largely moved sideways, ending the second quarter at 2,718, 5.4% below its high and 7.3% above its low.

    Year to date the global equity market represented by the MSCI All Country World Index (ACWI) has been relatively flat. For the first half of 2018, the ACWI generated a slightly negative return of -0.13%. The S&P 500, as the largest component of the ACWI, generated a positive return of slightly less than 3%. Most other regions, including Emerging Markets, Japan and Europe were down.



    Last year, the global economy experienced a synchronized expansion. Global real GDP growth accelerated to 3.8% in 2017 from 3.2% in 2016. Euro countries, Japan and many emerging markets moved from laggards to leaders in global growth.

    The opposite pattern is occurring in 2018. Global growth has slowed and the U.S. is the only major economy where leading economic indicators are still rising. The latest tracking data suggest that U.S. real GDP growth could reach 4% in the second quarter, more than double most estimates of trend growth. 

    This lofty pace cannot be sustained. For the first time in over a decade, the U.S. economy has reached full employment. The unemployment rate stands at a 48 year low of 3.75%. The number of people outside the labor force who want a job, as a percentage of the total working-age population, is back to pre-recession lows. For the first time in the history of the Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey (JOLTS), there are more job vacancies than unemployed workers. 

    In addition, the central bank is raising rates, equity valuations are relatively high and forward earnings estimates are at their highest level in nearly 20 years (see chart below).  All of these factors indicate that the U.S. is in the late stages of an expansion.



    As the chart shows, even with high expectations, the market can overshoot to the upside and equities may rally to fresh highs before this cycle is over. Given our bias for capital preservation and view that it is the late stage of this business cycle, we think it is prudent to be moderately defensive. However, we do not believe we are on the cusp of a recession. Traditional recession signals that we watch do not suggest a recession is imminent. For example, the spread between yields of 2 year bonds and 10 year bonds is falling, but still positive. This metric tends to turn negative approximately 12 to 14 months before recessions commence. Leading indicators (LEIs) also usually fall below zero when a recession is imminent. The May LEI rose by 6% year over year. Initial claims for unemployment insurance for the week ending June 16th were 24,000 below their reading six months earlier. Typically, a six month increase in unemployment claims of between 75,000 and 100,000 would presage a recession. Absent a recession, equity market corrections tend to be shallow and short-lived.



    Our rule of thumb in investing is to ignore politics and focus on fundamentals. This has served us well. However, we view trade differently. We believe many investors and politicians may be underestimating the potential consequences of tariffs.

    In our opinion, a trade war is one of the greatest risks to the U.S. equity market. The current cycle has not been about top-line growth. In fact, in terms of revenue growth, this has been one of the slowest recoveries on record. This cycle has been defined by the exceptional margin progression of “manufacturers,” defined broadly as companies who make something somewhere.

    The S&P’s steady rise in profit margins over the last two decades has been driven by manufacturers. There are currently 182 manufacturers in the S&P 500. Their net margins have risen from 8% in 2000 to 14%, an astounding 75% increase. Roughly half of the manufacturing stocks are drawn from the technology, industrial capital goods and auto sectors, and represent about a quarter of the earnings of the entire S&P 500.



    While there have been four primary drivers behind margin expansion: moving production to lower cost regions, lower interest expense, benefits of robotics and automation, and a decline in effective tax rates, globalization has been the gift that just kept on giving. The world operates far differently than it did 20 years ago. Sales from foreign affiliates of U.S. multinationals are roughly $6 trillion, nearly four times the $1.6 trillion of exported U.S. goods. The U.S. trade position with China looks decidedly more balanced when revenues from foreign affiliates of U.S. companies are taken into account.



    Trade is no longer a matter of producing goods in one country and selling them to another. Trade is now dominated by intermediate goods. The exchange of goods and services takes place within the context of a massive global supply chain. Automobiles, technology and apparel are produced from components sourced all over the world. Some components cross borders multiple times. As a result, trade in intermediary goods (components) now exceeds both trade in primary goods (raw materials) and finished goods. This arrangement has many advantages, but it also harbors numerous fragilities. A small fire at a factory in Japan that manufactured 60% of the epoxy resin used in chip casings led to a major spike in RAM prices in 1993. Flooding in Thailand in 2011 wreaked havoc on the global auto industry. The global supply chain is highly vulnerable to even small shocks. We believe the impacts of a global trade war would be seismic by comparison. Given current lofty earnings expectations, a trade war would likely inflict disproportionately more harm on the U.S. equity market than it would on the U.S. economy.

    Importantly, many industry reports are minimizing trade war impacts, particularly on equity markets. The analysis laid out in these reports is as follows: a 25% duty on $34 billion worth of products, which represents the amount of the first section 301 tariffs set to be imposed on July 6th, is roughly $8.5 billion, a fraction of the $800 billion in fiscal stimulus expected this year. Even if this amount is raised to include the $16 billion of Chinese imports that are under further review by the USTR and another $200 billion of Chinese goods under consideration for a 10% tariff, it will not approach the amount of stimulus. There is little discussion of the negative impact on companies and financial markets. Nor is there analysis of the implications to supply chains.  This underestimation will likely be revealed and its impact felt in financial markets later in the year when quarterly results begin to reflect companies’ increasing inventories on hand in anticipation of new and changing tariff and trade rules. Bottom line, although we have no way of handicapping the odds of a full blown trade war, the risks are clearly up. Like a nuclear standoff, the only thing preventing a trade war is mutually assured destruction.



    Things have gone from bad to worse for value investors, with value stocks underperforming in all regions around the world so far in 2018. While the performance gap is reaching an unprecedented level, we still do not see the catalyst to overweight value. Weaker global leading economic indicators and a stronger dollar clearly favor longer-duration growth companies.



    Among growth stocks, technology was again one of the market’s best-returning sectors in the first half of 2018, up almost 11% and outperforming the S&P 500 by over 800 basis points (8%), driven entirely by an increase in tech’s relative earnings multiple. Actual earnings growth was relatively muted. Moreover, year-to-date multiple expansion was broad-based across the tech sector, in contrast to last year when it was concentrated in a few stocks. The technology sector now trades at 1.13 times the market’s multiple on a capitalization weighted basis, higher than it has in nearly a decade, but still less than half of the peak reached in 2000. 

    The risk profiles of technology stocks have become significantly more favorable over the course of this cycle. Free cash flow margins have been rising for 20 years, due in part to a sustained decline in capital intensity. In the last four quarters, tech’s top-line growth rate has been double that of the market. These are fundamental strengths. As important, we don’t see signs of self-undermining excesses. None of the time-tested indicators of systematic risk – price volatility, share turnover, equity issuance, retail flows, or the performance of initial public offerings, are even flashing yellow. Tech’s free cash flow production has become large enough to be crucial to the outlook for the entire market. In 2005, the sector accounted for 20% of aggregate output and now that share tops 30%. In this cycle, the tech sector has been responsible for most of the cash flow generation of the market.


    Soon, almost every company will be a tech company in some respect. The leaders in this equity market: Facebook, Apple, Amazon, Netflix and Google, (FAANG), have not only reshaped the investment landscape, they have also reshaped the consumer by capturing their time and their wallets. As a group, they have added over $300 billion in sales over four years. The five FAANG companies now have as much brand equity as the top 50 consumer brands put together. Profits of these five companies now account for a greater share of the U.S. profit pool than all the large capitalization consumer staples companies combined. 

    We have recently trimmed some of our largest technology winners and will be closely watching for signs of relative weakness. However, leading companies today are nowhere near as “risky” as the leaders were 20 years ago. If the fundamentals remain solid, we will continue to own technology stocks that are some of our highest conviction thematic holdings.



    When 2018 began, still-strong global growth and extremely robust earnings led most fixed income analysts to predict that yields would rise across the curve and the U.S. 10 year bond yield would lift towards 3.5%. While the 10 year yield finally did exceed 3% for about ten days during the second quarter, the high point was only 3.11% and it closed the quarter at 2.86%, only 12 basis points (0.12%) higher than at the end of the first quarter. 

    The Fed has now hiked short rates seven times (175 basis points or 1.75%) and plans on two more this year followed by three next. The Fed’s balance sheet is now down $200 billion from its peak and is set to continue falling at a quickening pace into the fall. The spread between 2 year bond yields and 10 year bond yields fell to 33 basis points at the end of quarter. This is roughly the lowest spread since August 27, 2007. We are closer to an inverted yield curve today than at any point in this cycle.

    The Fed’s Summary of Economic Projections suggests a yield curve inversion next year (assuming long rates remain near current levels) and a 100 basis point rise in the unemployment rate, something that has never occurred outside a recession.

    Periods when the curve is flat are consistent with much lower excess returns than when the slope is greater than 50 basis points. Given the low potential reward, we believe sticking with a strategy of buying relatively short duration, high quality bonds makes prudent sense.

    We expect the 10 year yield will remain in a range between 2.50% and 3.00% until the threat of a trade war either lifts, in which case yields will likely rise across the entire curve, or a trade war causes a rush to safety and long term yields fall below 2.5%.

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