Quarter 2 2018 Market Update

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In our January report we wrote that we expected an uptick in volatility and that it was likely we would get the first correction since President Trump was elected, November 2016. That played out during the first quarter, with much of the volatility being attributed to news about trade tariffs being enacted (with markets dropping), often followed by news about negotiations (markets recovering those losses). Markets overall have absorbed this news pretty well and recovered some 12% from the February correction lows, an indication of how strong the current economy and markets are.

Our May report was titled “Expect a Barbell Year”, referring to a set-up that looked like most of this year’s gains may occur in the second half of the year. It still looks this way and shortly we will explain why.

Before we continue our discussion about the quarter just experienced and what we expect going forward, below are the asset-allocated Dow Jones Target Risk Index returns year-to-date as well as the returns for select widely followed individual equity and fixed income indices.

Returns as of 7/31/18

Returns provided by Morningstar as of 7/31/18.

Highlights from Q2-2018 (April-July)

Much of the news impacting markets during the second quarter related to trade disputes and concerns over whether they would escalate into a full-out trade war. The many sources we read indicate that for many reasons, it is likely that while short-term, tensions may escalate and then ease surrounding trade issues, in the longer-run it is much more likely that negotiations will occur that result in fewer tariffs overall, which is what the administration is seeking to achieve.

Second-quarter gross domestic product (GDP) was reported at 4.5%, the strongest quarterly growth in four years. According to Raymond James Senior Equity Portfolio Analyst Joey Madere, this is only the fifth time since the credit crisis that quarterly growth exceeded 4%. Consumer spending, which accounts for 68% of GDP, rose at a 2.2% annual rate in the first half of the year, while inflation-adjusted wage growth has remained pretty even.

For the past two years, Chief Investment Strategist, Jeff Saut, has stated that the bull market had transitioned from being powered by the Federal Reserve’s low interest rate policy to being powered by earnings. He has been correct as earnings continue to be quite strong with over half of the S&P 500 having already reported. Nuveen notes in their 2018 Midyear Outlook “U.S. corporate earnings growth should roughly double that of the rest of the world this year, thanks to reduced tax rates and other changes in the corporate tax code. But lower tax burdens are only part of the story. U.S. companies managed to grow revenues by nearly 10% in the first quarter of 2018.”

Globally, the economy remains solid also, but the overhang from Global trade concerns have impacted performance of investments globally so far this year. Any sign of easing trade tensions should be beneficial.

Expectations for Q3-2018 (August-October) …..

Historically, returns have been mixed in the equity markets during the month of August. According to the July 27, 2018 Weekly Update: Late Cycle, Late Schmycle, Linda Duessel, Senior Equity Strategist for Federated Investors, notes that during midterm election years, any weakness experienced in August is followed by a significant up-move that comes closer to the midterm elections and follows through to year end.  This is in agreement with other historical market data we have come across. Saut agrees as well, saying with this being a midterm election year, and given that the past four months have given positive performance, history suggests strong performance for the balance of 2018, again reinforcing our barbell theory.

And beyond

Nuveen notes in their 2018 Midyear Outlook conclusion that they maintain a positive economic and market outlook for the rest of 2018 and into 2019.

As this bull market stretches out yet another year we are on the lookout for signs of when the next recession could emerge. Duessel also notes that regarding the status of the current bull market, the economy is humming, Q2 earnings are on pace to rise 25% and that “In the past three U.S. expansions, the late-cycle phase lasted 2-4 years, indicating the next recession could be as far out as 2021” She follows by noting that “While timing the move from late to end cycle (bull market) is impossible, in the last three cycles, the equity market’s median cumulative late-cycle return was 42%”.

Currently, the path of rising interest rates and inflation (including wage inflation) indicate that one could come early in the next decade, as Duessel states. While the last recession was caused by the bursting of a major financial asset bubble, we suspect this next recession will be more run-of-the-mill, caused by the economy overheating and the Federal Reserve raising rates to slow it down. We are continuously watching the expansion cycle for indications that we need to become more cautious and will convey that when we feel the need.

Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc., and are subject to change. Past performance is not an indication of future results and there is no assurance that any of the forecasts mentioned will occur.

DJ GLB Aggressive Index - The DJ GLB Aggressive is a total-portfolio index that allow investors to evaluate the returns on their portfolios considering the amount of risk they have taken. These profiles are defined based on incremental levels of potential risk relative to the risk of an all-stock index. It's made up of composite indices representing the three major asset classes: stocks, bonds and cash. The asset class indices are weighted differently within each relative risk index to achieve the targeted risk level. The weightings are rebalanced monthly to maintain these levels. The DJ GLB Aggressive index is 100% of All Stock Portfolio Risk.

DJ GLB Conservative Index - The DJ GLB Conservative is a total-portfolio index that allow investors to evaluate the returns on their portfolios considering the amount of risk they have taken. These profiles are defined based on incremental levels of potential risk relative to the risk of an all-stock index. It's made up of composite indices representing the three major asset classes: stocks, bonds and cash. The asset class indices are weighted differently within each relative risk index to achieve the targeted risk level. The weightings are rebalanced monthly to maintain these levels. The DJ GLB Conservative index is 20% of All Stock Portfolio Risk.

DJ GLB Moderate Aggressive Index - The DJ GLB Moderate Aggressive is a total-portfolio index that allow investors to evaluate the returns on their portfolios considering the amount of risk they have taken. These profiles are defined based on incremental levels of potential risk relative to the risk of an all-stock index. It's made up of composite indices representing the three major asset classes: stocks, bonds and cash. The asset class indices are weighted differently within each relative risk index to achieve the targeted risk level. The weightings are rebalanced monthly to maintain these levels. The DJ GLB Moderate Aggressive index is 80% of All Stock Portfolio Risk.

DJ GLB Moderate Conservative Index - The DJ GLB Moderate Conservative is a total-portfolio index that allow investors to evaluate the returns on their portfolios considering the amount of risk they have taken. These profiles are defined based on incremental levels of potential risk relative to the risk of an all-stock index. It's made up of composite indices representing the three major asset classes: stocks, bonds and cash. The asset class indices are weighted differently within each relative risk index to achieve the targeted risk level. The weightings are rebalanced monthly to maintain these levels. The DJ GLB Moderate Conservative index is 40% of All Stock Portfolio Risk.

DJ GLB Moderate Index - The DJ GLB Moderate is a total-portfolio index that allow investors to evaluate the returns on their portfolios considering the amount of risk they have taken. These profiles are defined based on incremental levels of potential risk relative to the risk of an all-stock index. It's made up of composite indices representing the three major asset classes: stocks, bonds and cash. The asset class indices are weighted differently within each relative risk index to achieve the targeted risk level. The weightings are rebalanced monthly to maintain these levels. The DJ GLB Moderate index is 60% of All Stock Portfolio Risk.

The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australia, Far East) index is an unmanaged index that is generally considered representative of the international stock market. MSCI Emerging Markets Index is designed to measure equity market performance in 23 emerging market countries. The index’s three largest industries are materials, energy and banks. The Russell 2000 is an unmanaged index of small cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The Bloomberg Barclays U.S. Corporate High Yield Bond Index is composed of fixed-rate, publicly issued, non-investment grade debt, is unmanaged, with dividends reinvested and is not available for purchase. The index includes both corporate and non-corporate sectors. The corporate sectors are Industrial, Utility and Finance which include both U.S. and non-U.S. corporations. An investment cannot be made in these indexes. International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. These risks are greater in emerging markets. Small and mid-cap securities generally involve greater risks. Companies engaged in business related to a specific sector are subject to fierce competition and their products and services may be subject to rapid obsolescence. There are additional risks associated with investing in an individual sector, including limited diversification. The performance noted does not include fees or charges, which would reduce an investor's returns. Asset allocation and diversification do not guarantee a profit nor protect against a loss. Debt securities are subject to credit risk. A downgrade in an issuer’s credit rating or other adverse news about an issuer can reduce the market value of that issuer’s securities. When interest rates rise, the market value of these bonds will decline, and vice versa. While interest on municipal bonds is generally exempt from federal income tax, it may be subject to the federal alternative minimum tax, state or local taxes. Chris Bailey is with Raymond James Euro Equities, an affiliate of Raymond James & Associates, and Raymond James Financial Services. Material prepared by Raymond James for use by its advisors.