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February 2020 Economic Commentary

The markets have started off 2020 with the same anomalous behavior that we have seen in the last five years. Money flow has been heavily concentrated toward US Large Cap Growth with everything else falling by the wayside. As of mid-February, the NASDAQ 100 has outperformed most other asset classes around the globe by over 500 basis points. In fact, just four stocks, Microsoft, Google, Amazon, and Apple are responsible for almost 70% of the S&P 500’s gain, while only constituting 17% of its market cap. We own all four, though not in the same concentration as the S&P, which continues to morph into a very risky index.  
This concentration in mega cap technology also explains why the S&P has held up in the face of the coronavirus threat, trade uncertainty, and a general economic slowdown. While many industries, including travel & leisure, oil & gas, and materials are heavily impacted, these four mega cap tech companies have been somewhat immune, as their business models are rooted in avoidance of human contact and the ability to work and conduct business from home, as well as artificial intelligence, robotics, and big data. Other than the risk of supply chain disruption, these trillion-dollar companies seem ideally suited for a world of pandemics; logistics personnel can get products directly to consumers in the home and life management content from the cloud is delivered through a mobile device—very little direct human interaction required. 
Another dubious aspect of the current market is in fixed income, where flight to quality has led to a significant drop in the ten-year Treasury yield. Yields around the globe seem distorted based on continued central bank intervention. With close to 25% of sovereign yields in negative territory, it has become a formidable task to assess risk within the fixed income market. Who would have thought the Greek ten-year bond that yielded close to 19.5% four and a half years ago now yields just 0.98%, more than 60 basis points below the equivalent US Treasury bond. Has Greece really fixed their fiscal situation to that degree? The answer is not even close.
Navigating this landscape continues to involve both opportunity and peril. The growth story is still the most investable thesis if you are willing to pay up for it. Finding growth at a reasonable price has become a specialty for us, and there are still names out there that we find interesting. Adding yield to the portfolio has also become more art than science. With credit risk hard to assess given explosive liquidity, we still prefer the best in class large cap dividend growers that are yielding at least 75 basis points over the S&P 500 dividend yield of 1.73%. In addition, some corporate bonds remain attractive.
As the expansion continues to age, we have built on our defensive investments in gold and 20+ year Treasury bonds, whose price has a strong negative correlation to equities. We are also focusing on making an infrastructure investment soon. This is one area that is sorely needed and has bi-partisan support in Washington. In the most recent budget, over $1 trillion in infrastructure spending was proposed and, according to a recent article from Reuters, the world needs to spend $94 trillion on infrastructure by 2040 just to keep up with growth.  
Finally, I want to address the two biggest risk factors out there for global markets right now. Handicapping the effect of the coronavirus is proving difficult given the lack of clear data coming out of China. Most pundits believe the impact will be short-lived regardless of the magnitude. What appears to be fairly certain is that China is going to suffer a significant short term hit to GDP as a result of their effort to combat the virus. About half the country’s productive resources are literally shut down, and how this reverberates throughout the global economy remains to be seen. 

Please let me know if you have any questions via phone at 804-774-2087 or email at Jesse.Ellington@middleburgfinancial.com.

Past performance quoted is past performance and is not a guarantee of future results. Portfolio diversification does not guarantee investment returns and does not eliminate the risk of loss. The opinions and estimates put forth constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

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