For those of you that were unable to join us Thursday night, please click the Play button below to listen to our Investment Conference Call where I discuss the recent performance of the economy, markets and the role that international assets play in our portfolios.
The news cycle provoked a relatively high degree of volatility as well as wide variance in asset class returns during the second quarter. The US stock market shrugged off the tit-for-tat tariff scuffles and posted gains.
International markets were not as fortunate; emerging markets in particular had a difficult quarter. Real estate and small cap stocks achieved notable gains. Energy stocks were the particular standout, gaining over 10%. The ongoing trade confrontations have yet to have any measurable impact on economic statistics.
The world endured an uncomfortable degree of political uncertainty and strife. The effects of the 2016 American election as well as other votes around the world continue to have significant geo-political ramifications. Remarkably, markets seemed to take political gyrations in stride and remained focused more on business and economics. The early months of 2018 proved especially challenging as technology stocks came under political scrutiny and trade conflicts erupted.
Most national economic statistics were relatively strong. The year was exceptionally positive for the American economy and consumer. Moderate growth continued, purchasing power gathered strength due to low inflation, and wages rose a bit faster than in previous years as the employment market continued to expand and participation increased.
The prevalent view in recent years has been that interest rates had nowhere to go but up. Despite that consensus, rates have remained extraordinarily low. For years, the Federal Reserve has warned of the imminent onset of inflation, given economic growth and low unemployment. However, that inflation has yet to arrive, to the consternation of some, but to the relief of many more. It remains to be seen if the large tax cut passed at year-end 2017 will fuel inflation. Investors have remained skeptical, with long-term interest rates remaining fairly stable, even as the Fed has raised short-term rates and signaled that more increases are coming.
Major Economic Events
Growth in the US was a bit above average. Employment expanded at an increased clip, inflation remained under control, and housing prices rose. Consumer confidence surged, and spending remained fairly high. Savings, on the other hand, have fallen.
Every major region experienced economic growth, although there were some sputters in 2018. Europe’s economic recovery faded a bit. The British economy underperformed. Contrary to what most expected however, the Brexit soap opera has not had a drastic effect on British and European economies.
OPEC demonstrated restraint over the supply of oil and this had the effect of pushing prices upward. Demand rose as well. Nevertheless, American shale producers have proved quite resilient and it seems unlikely that there will be a huge oil price spike. The US is poised to become the world’s largest oil producer in the near future.
The Equity Markets
US stocks fell in the first quarter of 2018, breaking a string of nine consecutive gains. The stock market rally then resumed in spring. Despite increased volatility, the broad US equity market ended the twelve month period with gains of roughly 14%. Technology stocks were the clear leader, while more stable sectors such as consumer staples and telecom providers lagged significantly. Growth stocks trounced value, a result due primarily to the impact of the tech stock boom.
Small-cap companies were standout performers with particularly large gains in 2018. Perhaps these companies have benefited from increased investor concern regarding the trade confrontations and its effect on the large globally-oriented firms??
International stocks lagged the US. The EAFE Index (predominantly Europe, Australia, and Japan) ended the year with gains of only half the gains of the S&P 500. Emerging markets fared a bit better overall, although the 2nd quarter of 2018 was brutal for several countries, particularly in Latin America.
Natural resource stocks surged in spring of 2018 and ended the year as the top performing asset class. (Note that this follows three consecutive years of losses). REIT prices fell during an inflation scare in February. A quick rebound left this asset class slightly ahead for the year.
Overall, the effects of diversification from the traditional S&P 500 index were neutral. Although international markets and REITs dragged on returns, small cap stocks and natural resources were positive influences.
The Fixed Income Markets
Bond prices fell in the first half of 2018, and this decline erased the gains produced during 2017. The total return of the US bond index was slightly negative: -0.5%. The Federal Reserve increased interest rates three times. Many corporate bonds fell in value as investors have grown more concerned with excessive debt on company books. International bonds fared slightly better and ended with small gains. Foreign central banks continue to actively intervene in the markets to keep interest rates low. Cash and similar investments have benefited from the Federal Reserve’s increases in rates.
It was an eventful three months (ended May 31st) for investors. Asset class returns varied widely. Most of the world’s developed markets (US, Europe, Japan) ended with small changes. Emerging markets lagged, with Latin America a particular sore spot. Other volatile asset classes rewarded investors. Real estate and small cap stocks achieved notable gains, and energy stocks were the particular standout, gaining over 10%. The ongoing trade confrontations with nearly every major trading partner have yet to significantly impact the markets.
Expect the US economy to post very strong growth numbers for the 2nd quarter. Perhaps as high as 4%?? The latest positive news came from a shrinking in the trade deficit - caused primarily by strength in oil exports and a surprising drop in imports.
The gradual interest rate increases by the Fed are having some tangible impacts. Combined with the sky-high stock market, we now have a situation where 3 Month Treasury Bills yield more than the dividend yield of the S&P 500.
Cash is coming back into vogue as a competitive asset class
Energy stocks have (finally) shown some life in recent weeks. After many months of significantly underperforming the S&P this recent rally has virtually wiped out that shortfall.
Energy stocks are highly correlated with the price of oil, which has also risen significantly lately.
The trade deficit rose quite significantly during the first year of the Trump administration. This despite the campaign's focus on this issue (regardless of its true economic importance).
Recently we have seen signs that the administration is turning its focus to this issue on several fronts.
Today's news is that there will be more of a concerted effort to talk the value of the dollar down. (thus making exports cheaper and imports more expensive).
The dollar which had already been fairly weak over the past six months had another sizable drop today to the lowest levels since early 2015.
Of course as we've seen over these past months, equity investors don't mind this at all. And not just US stocks. For instance emerging market stocks rose today for the 9th straight day.
Stock markets continued their remarkable rise during the fourth quarter. Stocks rose every month, and, in fact, have risen for 14 straight months through year-end. Volatility remains eerily low. Virtually every sector and geographic region had positive results. Bonds gained value in December and ended the period with a small positive return. The global economic recovery gained strength and the Fed raised short-term rates again. A large corporate tax cut was signed in late December, and this provided further impetus to the stock market rally.