July NewsletterSubmitted by Rademacher Financial Inc. on July 11th, 2018
The three major domestic equity indices ultimately ended in positive territory for the second quarter, after zigging and zagging on headline news, particularly towards the end of June. Volatility due to the threats of escalating trade wars continues to be an overhang on the market. In the past month, the administration has threatened an additional $400 billion worth of tariffs on Chinese goods, and reports circulated that the administration had planned to invoke an emergency economic power to restrict Chinese tech investment in the United States and implement export controls on technology transfers.
Uncertainty, in this case regarding global trade tensions, often leads to concern among investors. It seemed that investors were trying to digest somewhat conflicting reports of peak earnings, tariff threats and political divisiveness, shrinking yield spreads, lower unemployment and gradually rising inflation.
Foreign financial markets weathered an eventful month as well, as global tariffs hurt these traditionally more open economies. However, Raymond James European Strategist Chris Bailey believes that any lessening of these concerns – which remains very plausible – provides investment opportunities.
Despite end-of-the-month volatility, all of the major domestic equity indices were up for the second quarter. A longer view shows that the NASDAQ, the Standard & Poor’s 500 and the Russell 2000 ended the first half of the year in healthy territory, but the Dow Jones Industrial Average didn’t keep pace.
Here is a look at what’s happening in the economy and capital markets, as well as key factors we are watching:
“The U.S. economy is doing very well,” according to Federal Reserve (Fed) Chair Jerome Powell. The job market has continued to tighten. Inflation, as measured by the core PCE Price Index, has moved up near the Fed’s 2% goal.
Monetary policy is still accommodative, and Fed officials believe that further gradual increases in short-term interest rates are likely to be warranted. The Fed is trying for a soft landing, a task that has been difficult to achieve in the past.
Trade policy uncertainty has had a modest impact on the overall economy so far (more significant for some industries than others), but investors may fear that a broader trade war would be more disruptive to the U.S. and global economies.
Real gross domestic product (GDP) growth is expected to have picked up in the second quarter, but comprehensive benchmark revisions (due July 27) may shift things around.
Despite recent volatility, domestic equities have held up much better than the rest of the world with emerging markets getting hardest hit on trade tensions and the rising U.S. dollar.
Economic activity and earnings remain pillars of support for the U.S. equity market. Second-quarter earnings season will begin in a few weeks, and estimates have ticked higher since the end of a very strong first-quarter earnings season.
Raymond James Managing Director of Portfolio & Technical Strategy Michael Gibbs and Senior Equity Portfolio Analyst Joey Madere are looking to get more color from companies on the impacts of global trade negotiations, margins, inflation and interest rates. (I’ll keep you posted on Gibbs’ thoughts.)
In three instances since 1986, Fed tightening has led to an inverted curve that was then followed by a recession, but that pattern may not necessarily hold given some of the unique aspects of the current climate. Remember, the current economic run started from the depths of the economic crisis of 2008/2009.
It has been two and a half years since the Fed’s first hike (December 2015) which is significantly longer than what led to the past three inverted curves. There is no guarantee we will invert the curve resulting in a recession or that we won’t. The latest round of Fed hikes was preceded by more than seven years of zero interest rates and market effects spurred by quantitative easing.
Yields and spreads have shifted such that even investors in the highest tax brackets may optimize their short-term returns (i.e., five years and in) with corporate bonds.
The most recent bond activity appears to be a reaction to headline news. Although some information, such as the potential trade war, is inflationary in Drabik’s view, the safe haven trade into U.S. bonds is at least temporarily countering those effects.
Concerns about disruptions to world trade flows continue to build, particularly impacting emerging markets (e.g., the Indian rupee hit an all-time low against the dollar, and the Chinese stock market flirted with bear market territory).
In Europe, Germany experienced some unexpected domestic political instability as Chancellor Merkel faced a new challenge to her current political coalition.
European economic reform efforts appear to be taking a slight backseat to discussions of potential trade tariff responses and internal regional debates such as immigration.
Using conventional valuation criteria, both emerging and developed markets outside of the United States appear to be attractively positioned for medium-term capital growth and income investors.
We believe you should continue to make decisions based on your long-term goals. A well-diversified portfolio should allow you to participate in upside potential here and abroad, as well as serve as ballast against any short-term volatility. I will continue to monitor the trade tariff situation and report as it is appropriate.
On a Personal Note…
June definitely slowed down after May’s whirlwind. Rachel and I spent a considerable amount of time weeding and working on the yard. Rachel has continued her long run training regime and plans on run a “slow paced” marathon this fall. Any marathon pace would be fast to me! However, I have been diligent about going for my morning walk, weightlifting and bike riding. Ok, the bike riding wasn’t as consistent as it should have been. Maybe next month, I will tell you that I actually went for a run… Don’t hold your breath.
Rachel and I traveled to Santa Fe, NM in June. Rachel attended a glass fusing class while I worked from various coffee shops. Our mornings would start with a hike in the surrounding countryside. Unfortunately, it has been so dry that the National Forest Service and State Park closed all of the surrounding areas to any hiking or activity. The fire danger is at extreme levels. The pine trees at higher elevations don’t look very healthy as they have been dry for so long. However, there is a great park within the city of Santa Fe that we did most of our hiking in. Rachel enjoyed and learned a lot at her class. The class was taught by visiting artist Morgan Madison. I can’t wait to see the new techniques she learned put to work in her art. I’m also pretty sure that I have a new tool list of possible Christmas/birthday/anniversary gifts to choose from.
We hear from Katelyn at least weekly, she is working 6-7 days per week on the campaign in Sarasota, FL. It sounds like she is working hard and enjoying the work. Hard to believe that she has already been there a month.
Garrett is staying busy this summer between his summer programming job, taking a class at KU and working out - he doesn’t actually wind up with a lot of downtime. He has been going to the gym and weightlifting with me and I think he has been enjoying it. My earlier comment about running may have something to do with the fact that even though he may not be as strong as Dad he definitely is moving faster.
I’ll catch you next time.
Phillip A. Rademacher, CFP®
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