Market Watch – July 2018
We are pleased to provide you with our quarterly newsletter featuring the status of our investment class weightings, our interpretation of recent data and our outlook for the future. If you have any questions about any topic, we hope you will not hesitate to contact us.
Status of our Investment Class Weightings
Changes from our April 2018 Market Watch are noted in italic.
US Large Cap Sectors –
- Overweight – Financials and Health Care
- Neutral – Consumer Discretionary, Energy, Industrial, Materials and Technology
- Underweight – Consumer Staples
- No Weighting - Utilities
US Mid and Small Cap – Increase weighting for US Small Cap.
International Developed Markets – Decrease weighting slightly.
Emerging Markets – Decrease weighting slightly.
Alternative Strategies – Maintain all weightings.
We will target an average fixed income portfolio duration of about 3 to 5 years. Where appropriate we may add ultra-short bond funds, convertible bonds and floating rate securities to some portfolios.
Multi-sector Bond Funds – Maintain all weightings.
Investment Grade US Corporate Bonds – Maintain all weightings.
Investment Grade Global Corporate Bonds – Maintain all weightings
High Yield US Corporate Bonds – Maintain all weightings.
Investment Grade Municipal Bonds – Maintain all weightings.
Data – During Q2, the equity markets found firmer ground after a disappointing Q1. For 2018, we see the following benchmark returns: US Large Cap – DJIA (-1.81%) and S&P 500 (+1.67%), US Small Cap - Russell 2000 (+7.01%) and International - ACWX (-5.38%). Economic data during Q2 was mixed. GDP, the broadest measure of economic output, for Q1 showed an annualized growth rate of +2.0%, which followed stronger results in Q3 (+3.2%) and Q4 (+2.9%). Volatility (as measured by VIX) calmed during the quarter finishing Q2 at 15.93, below the long run average of 20.0. The Conference Board in reporting the May LEI (Leading Economic Index) forecast “solid growth but that the current trend, which is moderating, indicates that economic activity is not likely to accelerate.” During the quarter, the yield on the benchmark 10-year US Treasury rose from 2.74% to 2.85%. Monthly job growth averaged 174,000 in March, April and May as the national unemployment rate fell to a 70-year low level of 3.8%. New weekly unemployment claims averaged 222,833 in Q2, compared to 228,923 in Q1. Consumer confidence, as measured by the Conference Board, remained elevated though below the high level estimated in February. The June Manufacturing Outlook survey (Philadelphia Fed) suggested continued expansion of the manufacturing sector and indicated a slightly less positive outlook near term versus six months out. Inflation, as measured by the change in the Consumer Price Index, reached 2.8% and remained above the Fed target of 2.0%. Retail sales data was strong and data from the housing sector (focus on housing starts and new home sales) was again not conclusive.
Outlook – At its June 12/13th meeting, the Federal Open Market Committee (FOMC) raised its benchmark interest rate by 0.25% to a range of 1.75 to 2.00%. This hike, which was widely expected, was the seventh such increase since monetary policy tightening began in late 2015. The Fed remains on track to continue with gradual interest rate hikes projecting two more hikes of 0.25% in 2018. Most Fed officials expect the central bank will need three additional rate hikes in 2019 and one or two hikes in 2020, leaving rates in a range between 3.25% and 3.5% by the end of 2020. As the Fed moves toward tighter monetary policy and higher real interest rates, it should surprise no one that the pledge “to remain accommodative” was not to be found in its most recent statement. At his scheduled press conference Fed Chairman Jerome Powell offered this assessment of the US economy, “The decision you see today is another sign that the US economy is in great shape. Growth is strong. Labor markets are strong. Inflation is close to target.” With the US economy on firmer ground and unemployment at historic lows, the Fed is also continuing to reduce the size of its balance sheet which ballooned to $4.5 trillion in the wake of the financial crisis. Some progress is being made as the Fed has reduced its holdings (in many cases simply by allowing assets to mature without reinvesting the proceeds) by over $100 billion since the policy was announced in September. Monthly reduction targets of $50 billion will begin this fall. We will renew our view that the dual strategy of interest rate normalization and balance sheet reduction will be a difficult one for the Fed to execute and the potential for policy misstep is a risk to US stock price growth as we move into the second half of 2018. What does this mean for your portfolio now? During the last 6 tightening cycles dating back to 1998, stocks have performed well – it is typically not until after tightening goes too far that the next recession (and stock market decline) becomes more likely.
Is it a trade skirmish, war or just a conflict? However, you may choose to define the ongoing trade conflict it will continue to cast a shadow over global stock markets in the weeks to come. A recent Charles Schwab article offered this, “While there’s no precise definition to a trade war, the potential impacts are generally understood. The fear is that actions and counter-actions by the US and China could escalate to a point where they hamper trade and investment and hurt both countries. And escalating confrontations between the two economies could spill over to other countries, with the potential to considerably impact the global economy.” The market volatility seen thus far in 2018 is likely to continue well into the summer as the conflict continues. In 2017, the US trade deficit with China reached $375 billion as US exports were $130 billion and imports from China were $505 billion. The $350 billion trade deficit amounts to 1.8% of US GDP ($19 trillion). In comparison, the GDP of China is $11 trillion, of which $505 billion represents 4.6%. In 2017, US global exports reached $1.5 trillion of which $130 billion (or 8.6% of total) went to China. Approximately 10% of US exports to China are agricultural, particularly soybeans. Over $170 billion (about 33%) of imports from China are either cell phones, computers or telecommunications equipment. Domination by China in manufacturing the foregoing may reduce the ability of US multinationals to make successful supply chain adjustments, at least in the short term. From a negotiating standpoint, it would appear that China’s room to retaliate against US tariffs is limited by the fact that the US imports far more from China that it exports. In our view, this is about more than just trade deficits and tariffs, it is about changing the way we do business with China, which includes a leveling of the playing field for American companies doing business in China and the long desired increased protection of US intellectual property.