2018 3rd Quarter Outlook

July 11, 2018

Review of 2nd Quarter

During the second quarter, stocks showed a fair amount of volatility without truly going anywhere. There was a regular routine of several days of losses, followed by several days of gains. Over the quarter, U.S. stocks rose by 3%, while non-U.S. stocks fell by 2% (emerging market stocks fell by 8%). Bond returns were zero.

 

Over the past few months, the stock market has almost entirely reacted to a single factor – U.S. trade policy. As we mentioned in our commentary in April, the stock market does not like restrictions on free trade. On days when the U.S. has announced potential tariffs on foreign goods, and as foreign countries have retaliated by declaring their own tariffs on U.S. goods, stocks have declined. When trade negotiations between those countries have been announced, or there appears to be other signals that tariffs might be rolled back, stock prices have risen.

 

Despite the relatively high daily movements, the overall levels of the market have not varied much. During the second quarter, the highest cumulative quarter-to-date decline was 2%, and the largest cumulative gain was 5%. That quarterly range is relatively tight compared to most quarters in the history of the market.

 

State of U.S. Economy
Below is a table showing key economic and market indicators (as of June 30)1 :

The data continue to show the strength in the economy.  Volatility has occurred because of a concern that if a trade war persists, GDP growth may be affected (and in turn, profits and employment), and inflation, and consequently, interest rates may rise.  However, the general consensus among analysists is that impacts of a potential trade war will be short-term.   

 

Stock Market Outlook

In April we stated that as long as our trade policy remains unsettled, stock price volatility would likely continue.  That indeed has been the case.  But, as we’ve been describing for the past two years, the main reason for the increase in market values has been the rise in expected corporate profits.  As long as earnings growth is forecasted by analysts to continue – that is still the case – we don’t perceive there will be a significant decline in stock values.  Consequently, our long-term outlook remains positive.

 

Bond Market

Along with most analysts, we believe the Federal Reserve will continue its policy of slowly increasing interest rates over the next year or two.   As a result, yields on all bonds -- in particular shorter-term bonds – have risen.   In May, we recommended that investors consider reducing the average maturity of their bond portfolio slightly by including some short-term bonds in the allocation.  We continue to hold that belief.

 

Summary

The market volatility we saw in the first quarter has continued, mainly because of uncertainty about U.S. trade policy.  Despite that uncertainty, the economy remains strong, and earnings are expected to continue to grow.  Because of interest rate increases, we do recommend investors consider a slightly more conservative bond policy.  However, as is frequently the case, there is no need to alter a well-considered long-term allocation strategy.

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