‘Confusing’. If you look that word up in a dictionary, you’ll see something like “bewildering or perplexing” as its definition. Confusing could be a good way to describe the state of the market. On the one hand, you have a U.S. economy that may have come off one of its strongest quarters in years. On the other hand, there is continued threat of higher interest rates and a tumultuous trade war.
Before looking ahead, let’s see how the major asset classes fared in 2Q18:
Equities: Stocks were mixed in 2q18. Certain pockets did well whereas certain ones did not. For example, the Dow Jones Industrial Average Index was down 0.7% on the quarter and now in the red for the 2018 calendar year (-1.8%). The Dow’s multinational holdings are more prone to trade-related swings, whereas small caps*, up 7.8% for 2q18 & 7.7% YTD (Year-to-date as of 6/30/18), are not. Emerging stocks**, -8.0% 2q18 & -6.7% YTD, did not fare well. This brewing trade war between the U.S. and China, along with rising interest rates and the rising U.S. dollar, are causing many investors to flee from these so-called riskier areas. We think a good general proxy for global equities is represented by the MSCI AC World Index, which was up a modest 0.72% for the quarter, and now about flat (-0.2%) for the year.
Fixed Income: Yields continued to go up, boosted by the same concerns as last quarter: increasing expectations for growth and inflation in the wake of the recent $1.5 trillion tax cut. The Barclays US Aggregate Bond Index, dropped a modest 0.16% for the quarter and now down 1.6% YTD. The Barclays Global Aggregate Bond Index fell 2.8% (and now down 1.5% YTD) as emerging market bonds suffered for same reasons as mentioned above for emerging market equities.
Alternatives: The Credit Suisse Liquid Alternative Beta Index, our chosen proxy for alternatives, registered a +0.4% for 2q18 and now off only 1.3% for the year. Gold*** suffered, -3.5%, however REITs**** and MLPs† had nice quarter returns of 5.8 and 11.5%, respectively.
Like others, you may be thinking something like this right now: “Thank you for providing color on the various assets classes, but I’m still confused. How did a balanced investor fare overall? And where do we go from here?”
Overall, most balanced investors had modest gains for 2q18 and are pretty close to where they were when they started the year.
As for looking forward, we think the area causing the most confusion and uncertainty is the tariff trade war issue. A lot of this is political noise which has weighed down stock prices. What has been, or will be, enacted is quite different than what is being discussed. We are hopeful that the countries can eventually reach a compromise on trade.
In the meantime, the US economy is red hot, with GDP nearing 5.0% and unemployment levels near lows not last seen since 1969. The upcoming earnings season should be exquisite! But all of these positives get analysts worried that the economy may overheat. The Fed’s goal is to raise interest rates enough to keep enough pressure on the brakes of this economy to control inflation, but not too much where it comes to a screeching halt. That being said, inflation is a little bit above the Fed’s target level and as such we would expect to see the Fed continue to raise rates gradually, perhaps for the next 4 -5 quarters. They’ll most likely need to stop at some point as the economy cools when some of the Tax Reform stimulus wears off in the second half of 2019. It’s not an easy job.
“I’m still confused - should we be worried about a recession in the near future?” While we don’t see it happening any time soon, it definitely is an increased possibility, and at some point, will inevitably occur. The goal is to be prepared for it. Don’t let emotions get in the way. Stay diversified and stay invested. Trying to time the market is a losing proposition. A good wealth manager can help you stay disciplined.
The good news is that the next recession will most likely be milder than the last couple for a few reasons including the following:
- Economies, both here and abroad, are simply more stable than in the past.
- Valuations are fine today. The forward 12-month PE (Price-to-Equity Ratio) of the S&P500 is right in-line with its 25-yr average of 16.1. International stocks, as represented by the MSCI ACW ex-US Index are even cheaper, trading at a 13.0 forward PE.
- The Fed certainly does not want another 2008 on its hands. They will continue to be friendly to market participants.
Still confused? Hopefully not. But if you are, talk to a wealth manager like DWM. If you look at antonyms for confusion, you will see words like “calm”, “peace”, and “happiness”. That’s what our clients want and what we seek to provide them.
Brett M. Detterbeck, CFA, CFP®
DETTERBECK WEALTH MANAGEMENT
**represented by the Russell 2000 Small Cap Index
**represented by the MSCI Emerging Markets Index
***represented by the iShares Gold Trust
****represented by the iShares Global REIT
† represented by the UBS AG London BRH ETracs Alerian MLP ETF