THE PAST QUARTER HAD ITS FAIR SHARE OF MARKET-MOVING EVENTS, INCLUDING ANOTHER FEDERAL (FED) RATE HIKE, A FLATTENING YIELD CURVE, GEO-POLITICAL EVENTS AND POTENTIAL TARIFF WARS. After last quarter’s volatile downturn, second quarter results brought overall year-to-date market returns back into positive territory. This reflects the continued low inflationary expansion of the U.S. economy and the related strong growth in corporate profits.
EQUITIES The U.S. Stock market rallied, gaining 3.89 percent while the broader Bond Markets continued their slide, down 0.16 percent respectively. Internationally developed markets (Europe, Japan, Canada) were down marginally 0.75 percent for the period. Unlike the first quarter when they were the top performing asset class, Emerging Markets were the worst this quarter, selling off sharply, down 7.96 percent. A globally diversified portfolio of 50/50 stocks/bonds earned a modestly positive result, up 0.57 percent for the quarter.
On the large cap side, growth stocks continued to outpace value stocks, 5.76 to 1.18 percent. Whereas small cap stocks, value outperformed growth, 8.30 to 7.23 percent – a first in several years.
FIXED INCOME The Federal Reserve continued its plan to increase rates in a measured way, increasing interest rates by a quarter point in June with at least one more additional rate increase expected this year.
The yield curve has been a popular discussion this year with questions about whether it will “invert”. An inverted yield curve means short-term rates rise above long-term rates. When this happens, typically it is a strong predictor that within 18 to 24 months, the economy will enter a recessionary period. Currently rates are tracking towards “inverting” by the end of this year. Even if that is the case, a recession would probably not begin until sometime in year 2020.
In addition to the U.S. Federal Reserve, the European Central Bank (ECB) announced its intention to cap its quantitative easing program, trending it down so it wraps up by year end. With this, the ECB may be in line to increase interest rates in Europe early next year.
ALTERNATIVES Looking over other investment categories, the U.S. REIT index rebounded sharply from its sizable first quarter sell-off and was the top performing asset class for the period, up 9.99 percent. The Bloomberg Commodity Index eked out a small gain, up 0.40 percent for the period, as the small net change masked the volatility underneath the index. Oil surged, up 16 percent at one end of the spectrum, and soybeans were down 18 percent at the other.
LOOKING FORWARD Both tax and regulatory reform provided a huge jolt to earnings in the first quarter and to estimates for the remainder of this year. When it comes to the connection between economic and/or corporate earnings and the stock market, it’s worth considering the often expressed view that “better or worse tends to matter more than good or bad”. This is true as it relates to earnings growth and their related stock prices.
Comparisons will begin to get more difficult, so expect a slowing in the year-over-year growth rate in corporate earnings. In addition, there are some high hurdles that earnings growth will face in the near-to-medium term, including potential trade tariff hits, rising labor and input costs, the strong dollar and rising interest rates.
Another reason to expect bouts of volatility is that we are in a midterm election year. History has not been kind to midterm election years in terms of stock market weakness. As always, a disciplined approach and a diversified portfolio continues to be the best approach to these times.
INFLATION During uncertain or volatile times, I get the question, why do I need to take any risks with my investments? One of the key reasons to not get too conservative is to protect against inflation. When prices of goods and services increase over time, consumers can buy fewer of them with every dollar. This erosion of purchasing power of wealth is called inflation. Therefore, a minimum of keeping pace with, if not ahead of inflation, is an important element of investing.
Over time, investments in stocks have historically strongly outperformed inflation as outlined on the attached article from Dimensional Fund Advisors. Whereas investing in “low risk” investments such as short-term Treasury Bills have actually badly lagged inflation. The lesson here is that volatility is not the only type of risk that should concern investors. Ultimately, investors need to have a portion of their portfolio allocated to growth investments that can outpace inflation to help maintain their standard of living and grow their wealth. I hope you find the attached article educational and enlightening.
We greatly appreciate the opportunity to work with each of you and hope you have been enjoying your summer. As always, if you have any questions or concerns, please contact us and we will be happy to discuss.
Please click here to read the complete TFA Quarter in Review | 2Q 2018.