Economic Update – Third Quarter 2018

Kent Forsey, CFP® Corporate Earnings, Economic Update, Stocks

Hillspring Financial

July 10, 2018

Dear Friends, Clients and Associates,

I remember being told as a kid trying to learn the fine art of hitting a baseball, “Always keep your eye on the ball”.  A similar idiom in investing would be “Always keep your eye on corporate earnings”.  So far this year, S&P 500 companies returned 24.8% in the first quarter over last year’s first quarter, and are set to increase 20% in the second quarter over last year.  Why then, does the market not seem to want to reflect the positive earnings that are happening and are forecast to happen?  There is plenty to create worry and fear in the markets, but earnings or the lack thereof will continue to be what ultimately drives stock prices.  The above reminder is an important focus point when trying to stay patient with a market that doesn’t seem to have any direction.

Market Recap

US stocks have risen to the top of a slow year for all asset classes with a solid rebound in the second quarter with smaller-cap stocks outdoing large cap (7.9% to 3.4%).  YTD numbers are 7.7% and 2.6% respectively.  The dollar’s appreciation of over 5% in the second quarter created headwind for dollar-based foreign securities.  Last year’s returns for Emerging Markets EM (31.5%) and Global Developed Markets (26.4%) gave a positive lift to most of our managed accounts exceeding the S&P 500’s return of 21.7%.  This year, however, we are seeing the reverse as Emerging Markets and Global Developed Markets are down YTD -7.3% and -2.8% respectively.  In addition to the currency effects, markets were buffeted by the continuing on-again, off-again (and back on again) trade tensions between the United States and Europe, Mexico, Canada, Japan, and China-in other words, all its major trading partners.

Moving to the bond markets, the benchmark 10-year treasury pierced the 3% level, hitting a seven year high, then fell back ending the quarter at 2.85%.  As such, the core bond index (Vanguard Total Bond Markets Index) has a negative return YTD -1.7%, (bond yields and bond prices move inversely to each other).

Looking ahead for the rest of 2018

Lingering concerns that continue to weigh down the markets include:

  • A potential trade war with China
  • Deceleration in global growth outside the United States
  • A stronger US dollar coinciding with rising US interest rates and tightening Fed monetary policy

Even so, the most recent US economic data points to 2018 GDP growth of 3% (60 year average is 3.19%).  With a pickup in consumption due to lower taxes and increased government spending from fiscal stimulus, the boost to economic growth should continue into 2019.  Although it’s realistic to expect that the tax cut boost to corporate earnings and personal consumption will begin to moderate, it’s possible the GDP growth in the second half of 2019 could slow to the 2%, but a real recession or slowdown is still 2-3 years out, notwithstanding any unforeseen escalation in the current trade war or other major unforeseen economic oddity.

Beyond the strength of the US economy, the global economy remains in pretty good shape, with real GDP growth expected to be above trend again this year (the consensus forecast seems to be in the 3.5%-4% range).

Conclusion

Every market at almost every point in time is always climbing a wall of worry.  It is understandable that fears of a global trade war are rattling financial markets.  President Trump’s unconventional negotiating approach adds an additional wildcard dimension.  The process is likely prone to several twists and turns before things become any clearer.  A protracted trade war wont’ help any economy. We do feel that cooler heads will eventually prevail.

As to how and when things ultimately play out, there is always uncertainty, and always risk when investing in equities.  This is why an investor must stick to their long term plan-assuming it was well designed and aligned with their financial objectives to begin with.  We continue to strongly believe our globally diversified portfolios are positioned to perform well over the long term and to be resilient across a wide range of potential scenarios.  Should the current trade tensions resolve, and the global economic recovery continue, we expect to generate good overall returns, with outperformance from our European and EM equities positions, active managers, and flexible bond funds.  Alternatively, should a bear market strike, those in our balanced portfolios have “dry powder” in the form of lower –risk fixed-income and alternative investments that should hold up much better than equities.  We`d then expect to put this capital to work more aggressively by, for example, reallocating to US equities at lower prices and higher expected returns sufficient to compensate us for their risks.

As always we think we have the best clients and we thank you for you continued confidence and trust.

Sincerely,

Kent G. Forsey, CFP®
President