Second Quarter 2018 Market Review

The first half of 2018 was marked by a sharp rise in volatility with political uncertainty, threats of global trade wars, and the Federal Reserve raising interest rates.

If we take a step back and reflect on what’s happened this year, market fluctuations have continued since February when we saw the first market correction, defined as a 10% drop, in two years. Market news in the spring continued to be heavy with the continued talk of trade wars, political arm wrestling, and inflation fears. We have yet to see the traditionally quiet summer months, and yet despite all of the news and continued volatility, stocks are near their highs for the year.

Currently in one of the longest bull markets in U.S. history, this volatility (which is here to stay) has naturally led to growing concerns about what may happen for the rest of the year and into 2019. The U.S. economy remains healthy, with strong real GDP forecasts for the second quarter starting to come in this week. Business confidence is high and corporate earnings also remain robust, with the number of jobs available greater the number of unemployed for the first time in history. While economic strength and a tight labor market suggests increased capital expenditures that may bode well for the stock market, we need to be careful of setting unrealistic expectations.

The Fed has several modest hikes planned for this year to normalize rates and curb the threat of inflation, which we are also seeing done at a growing number of the world’s central banks. Investors often attribute rising short-term interest rates with falling stock prices, yet this is not necessarily the case. Over the last two decades there has been a very low correlation between the two, and while rate hikes tend to increase market volatility, this is more an angst for investors and not necessarily a signal of an impending market downturn. Contributing to the volatility is that we are in a midterm election year and merely the uncertainly of the election outcome tends to cause greater volatility.

The Fed has expressed little concern about the flattening of the yield curve leading to an inversion, which is an interest rate environment where long-term bonds have a lower yield than short-term bonds, and tends to be a predictor of economic recession. Despite the media and public attention, the risk of a recession remains low and Chairman Powell remains bullish on the economy. Many believe that the flattening curve will not be a problem as long as rates are not hiked too aggressively. This is something to watch, but ultimately there are a lot of market factors that need to be considered as well. That being said, the Fed is often late in policy decisions so it is important to focus on economic indicators as well.

Then there are trade wars and tariffs, of which the latest surprise announcement between the U.S. and European Union has at least temporarily defused the situation. Hopefully this progress will continue, but we are elevating our concerns since we last commented on the topic, as it has become a leading concern expressed by business leaders. Often a concern or fear by itself can lead to problems in the economy.

Where does all of this information lead us? We are becoming more and more cautious and believe that recent market trends are quite reminiscent of the late 1990’s and early 2000’s. We often discuss with our clients that the market is a leading indicator that tends to be very good at understanding the numerous financial and economic trends well in advance. For this reason, the economic data tends to look very good near the end of the bull market cycle and quite the opposite at market bottoms. While there may be more worries now than at the beginning of the year, there are still signs of healthy economic growth.

It is important to remain consistent with our investment approach and we continue to urge our clients to remain patient and stick with their disciplined, diversified asset allocation based on their risk tolerances and goals. As your advisor, we are continuing our focus on the fundamentals of the investments we own in your portfolios. Volatility is here to stay, and we will continue to monitor the markets and make adjustments to your portfolios as necessary.

We hope you enjoy the rest of the summer, and please feel free to reach out if there is anything you need.

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