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Market Commentary: Second Quarter 2019

Market Commentary: Second Quarter 2019

June 30, 2019
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Executive Summary

Economic expansion since the Great Recession has now been the longest in U.S. history. All prior long booms had common elements:1

  • Policy shifts towards freer markets.
  • Tax rates were lowered.
  • Free trade increased.
  • Welfare reformed.
  • Policymakers held down Government spending.

By contrast, the current expansion occurred through tax hikes, increased regulation, and aging Baby Boomer demographic headwinds. Fear headlines over this period read: 

  • Double Dip Recession
  • Foreclosure fears
  • Municipal debt default fears
  • Cyprus banking crisis
  • China slowdown
  • Greece leaving the Euro
  • Fiscal cliff
  • Brexit
  • Obamacare
  • Quantitative easing
  • Quantitative tightening

Regardless of one’s political convictions, emotions fluctuated up and down like a yoyo. Yet, the market continued to climb as the economy maintained its expansive state.

Policy has now shifted pro-growth through corporate tax cuts, deregulation, full expensing for plant and equipment expenditures, and continued accommodative monetary policy. The U.S. economy has responded favorably with accelerating growth and low unemployment. While markets have reached new highs, we do not see an imminent risk of recession and expect valuations to be higher at year-end.

International trade disputes have caused market disruptions but are likely to be resolved. Government spending remains problematic but not to the point of creating problems for the economy now.

Regime Uncertainty

The Gatewood Wealth Solutions Investment Committee is using the term “Regime Uncertainty”2 to explain and understand the current market environment. Regime Uncertainty is a concept developed by economist Robert Higgs3 to describe a pervasive lack of confidence among investors to deploy capital. The reluctance is specifically due to political institutions changing well established rules. Policy uncertainty may refer to uncertainty about monetary or fiscal policy, the tax or regulatory regime, or uncertainty over electoral outcomes that will influence political leadership.

Let’s explore examples that demonstrate how uncertainty impacts capital investment.

Uncertain Tariffs

Imagine a business looking to build a factory in another foreign country such as China. With concerns about import tariffs, the company may delay committing dollars to invest in the overseas factory.

A business owner client recently explained his company’s challenge to determine next year’s prices for its products since proposed tariffs may result in material costs increasing up to 50%. Passing this increase along may result in lost market share if competitors maintain current prices. Holding prices may result in significant losses to the company and cause undue financial strain if material costs indeed increase.

Uncertain Monetary Policy

It’s no secret that the current Administration, specifically President Trump, is not happy with Chairman Powell’s interest rate decisions. Powell follows a rules-based approach to determining interest rates. While the Federal Reserve was created to act as an independent institution with its Chairman unable to be fired, President Trump asked White House lawyers for options to remove Powell.4 Should this happen, he would likely be replaced by a more “dovish” Fed Chair.

The Federal Reserve is supposed to be immune from political pressure. Should this independence be disrupted, the Fed’s credibility would likely be questioned. Investor sentiment would shift wondering whether monetary policy would be ruled by political whims versus economic principles.

Uncertain Tax Policy & The Laffer Curve Effect

The Trump Administration promoted the recent tax code changes citing the Laffer Curve effect. In economics, the Laffer curve is a representation of the relationship between rates of taxation and the resulting levels of government revenue. The Laffer curve claims to illustrate the concept of taxable income elasticity—i.e., taxable income will change in response to changes in the rate of taxation.5

The belief was that tax cuts would fuel economic growth by such a degree that tax revenues would increase enough to make up for the cuts and generate excess revenues for the United States Treasury. This didn’t happen. Policymakers will soon debate raising the debt ceiling as its limit will be reached this next quarter.

The White House is also considering Capital Gains tax breaks. These are unlikely to pass through legislation, causing the White House to consider moving this forward through an Executive Order. Lower rates will likely cause investors to favor equities over other investment alternatives for the potential of obtaining higher after-tax returns. Such behaviors will impact security valuations differently than today.

Additional uncertainty surrounds the Democratic candidates who either advocate a much different direction in taxes, i.e. higher, or those who espouse new and more expensive social programs.

All these uncertainties impact how companies decide to invest capital as well as what individual investors choose to satisfy their personal wealth needs.

The Next Bear Market or Recession

Recessions are caused by economic problems, not the passage of time. We appear to be late in the business cycle. The analogy of the seventh inning is often used to describe where we are in the cycle. No one knows how long the seventh inning stretch will be. We may know how many outs there are in a game, but not how long it will take to get them.

We may have experienced a “soft landing” and an early cycle is about to begin. To stick with the analogy, we could go extra innings. Soft landing in the business cycle is the process of an economy shifting from growth to slow-growth to flat, as it approaches but avoids a recession. It is generally caused by Government attempts to slow down inflation and the Federal Reserve using its tools for quantitative tightening to fine tune interest rates and money supply.6

Despite slowing growth globally, the U.S. economy is doing well, and we do not see a recession as imminent. Unforeseen “Black Swan”7 events are always a risk. Black Swan is the metaphor that describes a significant event that comes as a surprise. These are what we refer to as “unknown and unknowable” risks.8 If they were known in advance, we could plan for them. Since they are not, we must be prepared to act when we see them.

Next Quarter

Certain uncertainties we face next quarter include:

  • Trade war continuing to dominate the headlines.
  • Immigration and the use of Executive Orders and other means to move the Trump Administration’s agenda forward.
  • Nigel Farage’s newly formed Brexit Party quickly elected and its potential impact on the European Union.9
  • France’s Eurosceptic populist leader, Marine Le Pen, claimed surprise victory over pro – EU President Emmanuel Macron.10
  • Tensions with Iran.
  • Federal Reserve Chairman Powell looks to lower interest rates.
  • S. Presidential election process begins.
  • Democrats call for 70% marginal income tax rates and “Medicare for All”.

We expect the U.S. capital markets to continue to outperform the global markets. If Regime Uncertainty slows business investment, why is the United States doing so well comparatively? The U.S. remains a rule-of-law nation with a well-developed legal system and secure property rights relative to other large economies. We believe this bodes well for continued, though moderated, growth.


As always, no one can predict the future. It is important not to act on short term market movement but on long term fundamentals. We may have reached market highs, but this does not mean the market cannot go higher.

We remain vigilant in managing portfolio risk. As we have discussed in prior Market Commentaries, it is important to have adequate cash reserves to insulate your portfolios from being liquidated at the wrong time and to seize opportunities when we do experience a significant market downturn.

Now that the market has reached new highs, this is a good time to review your cash position with your Lead Advisor as this may be a good time to raise additional reserves. You may also want to discuss your allocation to make sure it continues to reflect your objectives, time horizon, and risk tolerance.

Securities and advisory services offered through LPL Financial, a Registered Investment Advisor, Member FINRA/SIPC.


(1) First Trust: Monday Morning Outlook, “The Longest Expansion” July 1, 2019; Brian Westbury, Robert Stein, CFA®, Strider Elass.

(2) Mises Wiki, sponsored by the Ludwig von Mises Institute; Page “Regime Uncertainty”

(3) Robert Higgs (born 1 February 1944) is an American economic historian, economist of the Austrian School, and a libertarian anarchist. His writings in economics and economic history have most often focused on the causes, means, and effects of government growth. He is a Senior Fellow in Political Economy at the Independent Institute (since September 1994), and is editor of Independent Review (since 1995). He is an adjunct faculty member of the Ludwig von Mises Institute and is an adjunct scholar at the Cato Institute. Higgs is also a contributor to

Higgs has held teaching positions at University of Washington, Lafayette College, and Seattle University. He has also been a visiting scholar at Oxford University and Stanford University. Higgs held a visiting professorship at the University of Economics, Prague in 2006,[ and has supervised dissertations in the Ph.D. program at Universidad Francisco Marroquin.

(4) Trump Asked White House Lawyers for Options on Removing Powel, Bloomberg, By Saleha Moshin & Jennifer Jacobs, June 18, 2019, 10:24 a.m.

(5) Wikipedia, Laffer curve -

(6) Wikipedia, Soft Landing (Economics)-

(7) Wikipedia, Black Swan Theory - The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight. The term is based on an ancient saying that presumed black swans did not exist – a saying that became reinterpreted to teach a different lesson after black swans were discovered in the wild.

The theory was developed by Nassim Nicholas Taleb to explain:

  1. The disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology.
  2. The non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities).
  3. The psychological biases that blind people, both individually and collectively, to uncertainty and to a rare event's massive role in historical affairs.

Unlike the earlier and broader "black swan problem" in philosophy (i.e. the problem of induction), Taleb's "black swan theory" refers only to unexpected events of large magnitude and consequence and their dominant role in history. Such events, considered extreme outliers, collectively play vastly larger roles than regular occurrences.[1]:xxi More technically, in the scientific monograph 'Silent Risk',[ Taleb mathematically defines the black swan problem as "stemming from the use of degenerate metaprobability".

(8) The Known, the Unknown, and the Unknowable in Financial Risk Management: Measurement and Theory Advancing Practice (A Review), CFA Institute, By Francis X. Diebold, Neil A. Doherty, Richard J. Herring – Princeton University Press. Reviewed by Mark S. Rzepczynski. Book Review, 2011, Volume 6, Issue 1 -

(9) The Brexit Party is a Eurosceptic political party in the United Kingdom founded in January 2019. It is led by Nigel Farage. The party has 29 Members of the European Parliament and four Welsh Assembly Members. The party's first major electoral success was winning the 2019 European Parliament election in the United Kingdom after four months in existence. Established by Catherine Blaiklock, the Brexit Party campaigns for British withdrawal from the European Union in order for the UK to trade on World Trade Organization (WTO) terms. Generally described as populist, it draws its support from those who are frustrated with the non-implementation of the 2016 referendum decision and wish to leave the EU without remaining part of the single market or customs union. Many of its members were formerly of the UK Independence Party (UKIP) – Farage having led UKIP from 2006 to 2009 and from 2010 to 2016) – as well as from the Conservative Party, including high-profile defectors such as Ann Widdecombe and Annunziata Rees-Mogg. There have also been some left wing endorsements, such as George Galloway.

The Brexit Party styles itself as being focused on the restoration of Britain's democratic sovereignty, its primary policy being for the UK to withdraw from the EU and to trade on WTO terms until formal trade agreements can be made. On contesting the 2019 European Parliament election, the Brexit Party became the largest British party in that parliament and largest single European party overall.

(10) LePen Declares Victory Over Macron as Greek PM Calls Snap Election, Sky News, Monday May 27, 2019 -

(11) The following describes the asset classes that are referenced in these market commentaries and which make up the asset classes in our portfolios.

The U.S. Large Cap asset class is measured by the S&P 500 Index, which is a capitalization-weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The U.S. Mid Cap asset class is measured by the S&P Mid Cap 400 Index, which is the most widely used index for mid-sized companies and covers approximately 7% of the U.S. equities market.

The U.S. Small Cap asset class is measured by the S&P Small Cap 600 Index, a market value weighted index that consists of 600 small-cap U.S. stocks chosen for market size, liquidity and industry group representation.

The International Developed Markets asset class is measured by the Morgan Stanley Capital International Europe, Australasia, and Far East (MSCI EAFE) Index, which is composed of all the publicly traded stocks in developed non-U.S. markets. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

The International Emerging Markets asset class is measured by the MSCI Emerging Markets Index, which is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI Emerging Markets Index consists of the following 21 emerging market country indices: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand and Turkey.

The Real Estate asset class is measured by the Dow Jones US Select REIT Index. The index is a subset of the Dow Jones U.S. Select Real Estate Securities Index (RESI), which represents equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded in the U.S. The indices are designed to serve as proxies for direct real estate investment, in part by excluding companies whose performance may be driven by factors other than the value of real estate.

A Real Estate Investment Trust (REIT) is a tax designation for a corporation investing in real estate that reduces or eliminates corporate income taxes. In return, REITs are required to distribute 90% of their income, which may be taxable, into the hands of the investors. The REIT structure was designed to provide a similar structure for investment in real estate as mutual funds provide for investment in stocks.

The Commodities asset class is measured by the Bloomberg Commodity Index (BCOM), formerly the Dow Jones-UBS Commodity Index, which is a highly liquid, diversified and transparent benchmark for the global commodities market. It is calculated on an excess return basis and reflects commodity futures price movements.

The Global Equity Index as referenced in this report is the combination of the equity indexes listed above in proportion to Northwestern Mutual’s strategic asset allocation model for the equity aggressive model and as reported by Morningstar Direct as of 06.30.2018. 

The Barclays U.S. Aggregate Bond Index, formerly the Lehman Brothers U.S. Aggregate Index, which is an index of the U.S. investment-grade fixed rate bond market, including both Government and corporate bonds, measures the Taxable Fixed Income asset class. 

The Barclays Municipal Bond Index, which is a rules-based, market-value weighted index created for the tax-exempt bond market, measures the Tax-Free Fixed Income asset class, i.e. “muni bonds”. 


The opinions expressed are those of John Gatewood as of the date stated on this material and are subject to change. There is no guarantee that any forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment or security.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss. With fixed income securities and bonds, when interest rates rise, bond prices usually fall because an investor may earn a higher yield with another bond. Moreover, the longer the maturity of a bond the greater the risk. When interest rates are at low levels, there is a risk that a significant rise in interest rates can occur in a short period of time and cause losses to the market value of any bonds that you own. At maturity, the issuer of the bond is obligated to return the principal (original investment) to the investor. High-yield bonds present greater credit risk than bonds of higher quality. Bond investors should carefully consider risks such as interest rate risk, credit risk, liquidity risk, securities lending risk, repurchase and reverse repurchase transaction risk.

Investors should be aware of the risks of investments in foreign securities, particularly investments in securities of companies in developing nations. These include the risks of currency fluctuation of political and economic instability and of less well-developed government supervision and regulation of business and industry practices, as well as differences in accounting standards