Looking back, equity markets ended the quarter modestly higher despite all the same macroeconomic and political headwinds that it has been dealing with for several quarters.

In fact, the S&P 500 ended the third quarter less than 2% away from its all-time high and continued to appear relatively unfazed by the latest tweet, headline or data point. Conversely, bond markets were not as calm — the yield on the 10-year treasury bond fell another 35 basis points to 1.66%.

This comes on the heels of last quarter’s decline, with both now totaling an incredible 75 basis point decline since the end of first quarter 2019. Equities responded to the move lower in rates, as historical “bond proxies” like Utilities and Real Estate moved sharply higher and were the top-performing sectors for the quarter.

Investors reverted their “low interest rate playbook” of hunting for yield among the steady and stable business models of those sectors. More broadly, investors further segregated companies into similar buckets across the rest of the market, favoring high-quality, cash-generative businesses over those with large amounts of debt and greater levels of uncertainty over their future earnings and cash flows.

2019 Third Quarter and 1-Year Trailing Returns Across Asset Classes

Businesses with well-established track records of generating profits and cash flows trading at attractive valuations may not sound as appealing, but likely come with less risk to permanent capital loss, versus “high fliers” and potentially “world-changing” businesses that are unprofitable and reliant on raising additional cash each month, quarter and year just to survive. While statistics vary on this, some estimates are that upwards of 90% of startups fail within five to 10 years of their founding. While the story of WeWork is interesting, the broader implication remains the same as investors grapple with uncertainty in the markets.

A Look at WeWork’s Failed IPO

The clearest example today of investors’ preferences is the failure of the WeWork initial public offering (IPO). While chronicling all the happenings surrounding the failed IPO would take many pages, the drama roller coaster began in August for WeWork when they filed their IPO documents to go public.

Investors began closely examining their filings, to understand their path to profitability as well as their management team and structure. There were clear concerns by analysts as they tried to look forward to when and how the company would be able to grow. WeWork needed an increasing and accelerating amount of cash to continue acquiring additional offce space, as the company was currently not profitable, requiring that cash in order to pay its employees and current real estate lease obligations.

In short order, investors grew skeptical over whether the company would ever be able to turn a profit. Additionally, serious questions began to arise regarding governance, or how the company’s management team was structured and operated. The CEO and cofounder, Adam Neumann, came under fire for his leadership style as well as several decisions he made, and he eventually was replaced.

Ultimately, in barely over a month since its debut, the WeWork IPO was postponed for a later date. The valuation for the company over that period had come down nearly 80% from $47 billion to just $10 billion potentially at the end. This serves as a cautionary tale, much like the dot-com era from the late 1990s, for investors when thinking about long-term investment returns from businesses, both small and large.

 

Top Questions on Investors’ Minds Today

1

The economy — Fine or not fine? Growth remains solidly positive here in the U.S., with the most recent GDP reading of 2%, however, survey data from some industries, like manufacturing which appears to be slowing or even declining, raises the prospect for even further moderation of future growth rates.

Slowing in other parts of the globe remains a concern given the linkages between the major economies, though their data suggests some areas of the economy may be bottoming or turning higher.

The talk of a potential recession has increased as headwinds and uncertainty remains high, which continues to weigh on business confidence and capital investment decisions. However, company fundamentals largely remain solid as many continue to generate strong cash flow and have reasonable amounts of debt.

2

The Federal Reserve — How much punch is in the bowl? The Fed pivot was completed in July, when it cut their benchmark rate for the first time since the financial crisis in 2008, versus the original expectations for rate hikes as the year began. The Fed brought the “punch bowl” back, and so far, has cut rates 50 basis points with expectations growing for another cut before year-end. Investors continue to look for further support from the Fed and other global central banks to bolster global growth, even as the economy is currently still growing and markets remain near their highs.

3

Washington, D.C. — Fact or fiction? The continued trade war ongoing with China and the U.S. creates near daily headlines regarding either potential progress made or setbacks and snafus encountered. Investors and companies alike are growing weary with the constant stream of (mis)information, but this remains a large, potential swing factor for the U.S. and global economies if there were to be a comprehensive deal struck.

The media efforts for potential nominees ahead of the 2020 presidential election is also another factor. While many campaign promises are in the process of being made, certain companies and industries are potentially at-risk from these new policies and regulations being promised and remains something else to closely watch for investors.

While the market awaits answers to these questions, we continue to invest as long-term stewards of our clients’ investment funds and wealth plans with an eye toward the future, focusing on creating long-term value for our clients as we have done for over 35 years.

We remain vigilantly focused on protecting client capital during these periods of uncertainty and volatility. We strive to achieve this by investing in high-quality businesses generating strong cash flow and with balance sheets to weather any potentially disruptive storm.

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