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Fourth Quarter 2018

Happy New Year! All of us from the Wealth Management Group hope this letter finds you well.
Last January’s 5.7% return for the Standard and Poor’s 500 Index now feels like a lifetime ago. Investors were still giddy about the prospects for Bitcoin, the federal tax cuts were to propel earnings growth into perpetuity, the “Trump Bump” was in full effect and the one-month US Treasury yield was still only 1.4%. Our 2017 year-end musings about potential market headwinds did not look extremely prescient in February! The year ended with one of the worst Decembers in recent history for stocks. Below are the 2018 total returns for four major global asset classes:

Global Asset Class Returns: 2018
Domestic Bonds were the only primary asset class to post a positive return
Source: Bloomberg, LP, Standard & Poor’s, Wealth Management at Century Bank
In hindsight, the torrid January likely signaled the peak of investor exuberance for domestic stocks. The S&P 500 finished 2018 with a 4.38% decline. Global equities fared worse as both emerging market and developed international stocks lost over 14% each.

“Don’t Fight the Fed”
The expression “Don’t Fight the Fed” has historically discouraged against an over-exposure to risk assets during periods of rate tightening. The rationale is that the Fed generally tightens in the later innings of the economic cycle; this typically presages an eventual economic recession. The Fed’s quantitative easing policy pushed both short and long-term rates down, making interest-bearing investments like CDs, money markets, and bonds less attractive. This phenomenon drove investors to seek risk assets in hopes of earning a respectable return. Over the course of almost a decade of accommodative monetary stimulus, the Fed’s policy has fueled an element of financial asset inflation. When the proverbial punchbowl is taken away in the form of higher rates, investors start to reconsider parking money in short-term investments with more yield and less risk than equities. It is never a fun year when cash is one of the best performing asset classes! Below we plot the US Treasury yield curve at the beginning and end of 2018:
U.S. Treasury Yield Curve January 1, 2018
US Treasury Yield Curve: January 1, 2018 (Gold Line) & December 31, 2018 (Green Line)
Source: Bloomberg, LP
China: an emerging geopolitical risk factor
In December, Canadian police apprehended Huawei Technologies’ CFO, Wanzhou Meng, at the behest of U.S.
officials. Huawei is a Chinese firm that manufactures networking and telecommunications solutions.
Allegedly, the company is doing business with Iran through a shell company. Furthermore, Bloomberg Media
recently broke a story accusing Chinese intelligence of implanting tiny chips to infiltrate America’s high tech
supply chain. Despite what President Trump may say (or Tweet), it is becoming increasingly clear that
relations with China are on thin ice.

It is highly likely our national security establishment has been planning to act on industrial espionage and IP
theft long before President Trump took office. As a result, we do not believe trade tensions will be resolved
with one declarative Tweet. It goes much deeper than a trade spat. There has been a gradual yet consistent
tectonic shift in the balance of power between the United States and China over the past 20 years -- the stakes
have never been higher when it comes to getting Chinese trade and security policy on a sustainable path that is
mutually beneficial. While most pundits pay more attention to Chinese economic data to formulate global
growth estimates, we believe US policymakers and industry titans are finally calling China’s bluff: it is time to
stop stealing our best ideas and technology.

“Price is what you pay and value is what you get”
Famed investor Warren Buffett is credited with the above quote. Like most of his words of wisdom, this one
stands the test of time. For the past two years, we have expressed concern about the domestic stock market’s
valuation. The investment industry has done a fantastic job of complicating what we do. Perhaps this is out of
self-importance or even self-preservation. Despite the dynamic nature of what we do as professional investors,
at the end of the day our job is rather straightforward: expose our clients to a diversified stream of future cash
flows that we deem are justifiable at current valuations. In short, valuation matters over the long run. As a
result, we passed on Amazon, Nvidia, Netflix, and others over the past three-year period. We happen to love a
few of these companies, and candidly, we welcome a further pullback in hopes that the shares may become more attractively valued.

When December (finally!) came to a close, we were in fact more directionally constructive on equity markets.
We are aware of the myriad of lurking global issues – both economic and political – but assets are more fairly
valued today than they were at the end of the 3rd Quarter.

Disruption is your Friend
As we enter a new year it is always exciting to think about what the future will look like. In fact, one generally
finds more success predicting secular societal trends than short-term market returns! For example, I was
chatting with my wife recently about whether we should purchase a new car for the family. The general
conclusion was we are probably better off maintaining our dependable 135,000 mile Toyota for another 2-3
years. The reason is because it is highly likely considerable advances will be made in the nascent electric &
self-driving car space. Indeed, we expect the nature of commuting will look drastically different ten years from
today. Will city dwellers own cars parked miles away to reduce congestion? A simple app notification could
beckon the car for pick-up.
AI (artificial intelligence) and machine learning probably top the technology buzzword list for 2018. While it is
fun to joke about hype terms du jour, we do believe we are in the first inning of incredible advancements across
several sectors. The convergence of cutting-edge computer chips, cloud computing and mobile technologies
means the smart phones (and now watches) we carry around make phones from 10 years ago seem like a prize
my kids would get in a McDonald’s Happy Meal. These are exciting times despite the political discord of late.
So long as capital flows towards innovation and entrepreneurs have incentive to bear risk, standards of living
will continue to improve.
Mobile phone from 10 years ago
How soon we forget!
Thank You!
In conclusion, I would like to thank you for your partnership. As our group continues to grow, we are always
looking for ways to improve our process and add the most value for our client base. We are excited that Phil
McManus has joined the wealth management team as Equity Analyst/Portfolio Manager. Phil’s expertise in
domestic equity analysis enables us to become more active with respect to individual security selection.
We are excited to start a new year and believe certain asset classes are more attractively valued. While we
doubt the US economy will be entering an economic recession in 2019, there is risk that corporate earnings
estimates will not be met. We will take advantage of increased volatility to position our strategies for attractive
long-term risk-adjusted returns.
Carl R. Hall, CFA
Chief Investment Officer

Wealth Management at Century Bank logo.
Not insured by FDIC or Any Other Government Agency. Not Bank Guaranteed. Not Bank Deposits or Obligations. May Lose Value.

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