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Sorry for the Turbulence

There is no doubt that we have all heard these words come over the intercom at some point in our flying careers. The pilot does her best to assure us that despite the bumpiness everything is fine, and we should arrive at our destination on time. The pilot looks at the radar and does her best to estimate how long the turbulence will last. Sometimes the pilot may even increase or decrease the altitude of the plane if the turbulence gets really bad. Combine all this with a middle seat in the back of the coach section and the minutes of turbulence can feel like hours. Given the stock market turbulence on our radars, we don’t think it is necessary to adjust our altitude (i.e., allocation to stocks) at this time. We expect the turbulence to subside relatively soon. In our 2018 outlook and prior write-ups, our expectations were for stocks to continue advancing, interest rates to rise modestly, inflation to remain subdued, and the dollar to weaken. One month into our annual flight, that’s generally where we are with the exception that both stock prices and bond yields have risen a little faster than anticipated. U.S. stocks are up more than 4% YTD and 10-year bond yields have increased more than 40 basis points, going from 2.40% to 2.82%. The rise in bond yields is most likely causing the current turbulence. The fear among stock investors is that rising rates will slow the economy by increasing borrowing costs. While we can’t argue the fact that higher rates make mortgage payments, personal loans, and all borrowing more expensive, it’s important to recognize why rates are rising. Rates are rising because economic activity is increasing. The economic news is good, including this morning’s jobs report. The Federal Reserve stated in the release of their minutes this week that they will likely need to increase short term rates at a faster pace than previously anticipated. They’re not increasing rates due to immediate inflation concerns. The Fed’s concern is that the economy will eventually overheat if they leave the current, exceptionally accommodating monetary policy, in place too long. They are trying to get ahead of the proverbial curve and gradually start increasing rates now, so that they won’t have to play catch up later. As we said in our 2018 outlook and will continue to repeat, bull markets don’t die of old age. Bull markets die of recessions or material slowdowns in the economy. We don’t see that at this time. We studied previous Fed tightening cycles and would argue that this cycle is playing out exactly to the prior scripts. When the Fed starts tightening monetary policy, stocks sell off in the short term. Sometimes this can last several months, but usually it’s only a matter of weeks before investors acknowledge that an improving economy outweighs higher rates. We believe this is the current situation. The good news is that unlike when a real flight hits turbulence and the pilot orders the flight attendants to put the beverage carts away, we will allow the beverage cart to continue serving during our figurative flight. The Greenport Team

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