A Brief Market Recap
It’s been a long stretch of HOT weather here in beautiful Central Oregon while it seems market volatility and international politics have been just as scorching. As one of my favorite investment icons Sir John Templeton famously stated, “Bull Markets are born in pessimism, grow on skepticism, mature on optimism and die on euphoria.” The current Bull Market was certainly born in pessimism in March 2009, as many observers feared a global depression was underway. The skeptics have not been soothed by steady increases to record highs for GDP, earnings and dividends. Instead, they call the markets’ robust performance (the S&P 500 has gained over 300 percent) a delusion created by Central Bank policies and hyped by overvaluation.
In my opinion, the primary drivers of the 2009-2018 Bull Market have been the fundamental elements: earnings and dividend growth, accompanied by modest inflation and low bond yields. Many economists feel the risk of a reversal is currently small. Despite an almost four percent unemployment rate, wage growth remains contained and commodity prices remain well below cycle highs reached earlier in this decade. The fundamentals still appear solid.
While valuations are somewhat above average, they are far from euphoric for the broader market. There are always segments of the market that are more overvalued and in the current cycle, the NASDAQ 100 and S&P 500 Growth market-leading returns are being driven by the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google). The overall valuation of these and other technology/consumer stocks is a worry for many observers. It is hard to argue that point, but a correction in the FAANGs would not necessarily cause the prices of more moderately valued stocks to plunge. Likewise, earnings growth among the FAANGS remains high.
I like to say, we need stocks in our portfolio to live well yet bonds to sleep well and it’s about finding the appropriate balance. For this reason, it’s important to track interest rates. Although the Fed bumped its Fed Funds rate another 0.25 percent higher in June to a target of 1.75 percent-2.00 percent, the U.S. Treasury ten-year bond yield only increased 0.11 percent to 2.85 percent during the second quarter. Overall, the Barclay’s U.S. Aggregate Bond index was -0.2 percent for Q2 as weakness in Investment Grade Corporate Bonds (-1.4 percent ) offset positive returns for shorter term bond indexes such as three-Year TIPS +0.5 percent and short term High Yield Corporates +1.3 percent . The JP Morgan Emerging Market Local Currency Bond index fell -10.9 percent, as it was hit hard by emerging markets currency weakness and investor fears of the impact of potential trade wars.¹
It appears to us the overall U.S. stock market seems stuck in the skepticism/optimism segment of Templeton’s Bull Market sequence. This is partially explained by the presence of a few dangerous worries.
- First, the Fed is not as “friendly” as the beginning of the Bull Market. The Fed Funds increase in June was the 7th in this cycle and the Fed is gradually shrinking its bloated $4 trillion balance sheet. Calm U.S. inflation and ultra-low global bond yields continue to suppress the U.S. 10-year Treasury Bond yield. The yield curve hasn’t inverted yet but has flattened significantly.
- Second, geopolitical issues are an additional rational worry for investors. War, terrorism, nuclear weapons and cybersecurity issues are regular features of media headlines, but so far these worries have not translated into measurable economic or financial market impacts.
- Third, the consensus belief in early 2018 was that every major economy was expanding at once, creating a synchronized wave of growth which would create jobs and business investment. The optimism for a positive global feedback loop of growing business confidence leading to more hiring and improved consumer spending has since turned sour. The primary reason is a fourth worry, the risk of a trade war sparked by the U.S. President.
Few observers would argue with U.S. Secretary of Commerce Wilbur Ross’s statement, “The Chinese are protectionists dressed in free market clothing.” China’s well-documented theft of intellectual property also adds to tensions. If President Trump gathered a global coalition aimed solely at China’s unfair trading practices, investors might not be too worried.
However, his apparent belief U.S. trade deficits should be eliminated with all countries has led to greater worries: elimination of NAFTA and tit-for-tat tariff fights with our close allies that could escalate into a devastating global trade war. Although few of us experienced the Great Depression of the 1930s, politicians and investors are keenly aware of the role a trade war played in that debacle. The markets are very worried about this and have punished Emerging Market stocks and bonds as a result.
2nd Quarter Results:
The Callan Chart illustrates in a colorful format the asset classes that have performed well and the ones that have not on a monthly and annual basis. History shows that they are always in motion like a yo-yo. As you will see below, domestic equities (stocks) rebounded to post positive returns in Q2, after significant volatility and price declines in Q1. The U.S. Dollar also reversed direction and was partly responsible for declining prices for international equities. Here are the winners and losers for the past quarter:
Equity index leaders for Q2 included:
- U.S. REITS +8.9 percent
- S&P Small Cap 600 +8.8 percent
- NASDAQ 100 +7.3 percent
- S&P 500 Growth +5.2 percent
- Natural Resources +5.5 percent
- S&P Mid Cap 400 +4.3 percent
- S&P 500 +3.4 percent .
Laggards included:
- FTSE* Emerging Markets -8.4 percent
- Global ex-US REITS -2.8 percent
- FTSE All World ex-US (Developed International) -2.7 percent
- FTSE All World ex-US Small Cap -1.8 percent .
*The FTSE Group, is similar to Standard & Poor’s, that specializes in index calculation. While the FTSE is not part of any stock exchange, the co-owners are the London Stock Exchange and The Financial Times. FTSE is an acronym for Financial Times and Stock Exchange.
It’s prudent to follow the latest economic news and data however in the end I believe that your chance for success over the long term is most favorable when you diversify among all the major asset classes, rebalance your portfolio throughout the year and understand that it’s all about time in the markets and not timing the markets. I hope your second half of 2018 is off to a wonderful start.
¹Valmark Securities
David Rosell is President of Rosell Wealth Management in Bend. www.RosellWealthManagement.com. He is the author of Failure is Not an Option- Creating Certainty in the Uncertainty of Retirement and Keep Climbing─ A Millennial’s Guide to Financial Planning. Ask for David’s book at Newport Market, Sintra Restaurant, Bluebird Coffee Shop, Dudley’s Bookshop, Roundabout Books, Sunriver Resort, Amazon.com or Barnes & Noble.
Investment advisory services offered through Valmark Advisers, Inc. an SEC Registered Investment Advisor
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