3Q18 Market Overview
Despite the relentless trade talk headlines and unpopular tariffs, global equity markets overcame fears and extended gains. U. S. equities led the march higher by a wide margin as the U.S. bull market became the longest in history on August 22. China on the other hand slumped as the U.S. enacted an additional $200 billion in tariffs bringing the combined total to $250 billion.
As we close out the year, we are mindful of few potential obstacles that have the potential of extending the October market volatility. Most notable headwinds include the November mid-term elections, additional interest rate hikes and an all out trade war with China. Regardless of the outcome of these events, we should continue to benefit from late stages of the nine year U.S. economic expansion as companies continue to post impressive earnings results and positive future guidance. This guidance is expected to eventually factor in a global economic slowdown as trading partners adopt protectionist trade policies.
Our rebalancing process will shift towards our target allocations in the most tax-efficient manner possible while maintaining your desired risk level and fulfilling your cash flow or charitable funding needs. Given the sharper pullback in international markets and stronger U.S. dollar, our rebalancing process will favor selling elevated U.S. asset classes in support of value oriented investments that have proven to excel during the final innings of a global economic expansion.
U.S. Equity Markets
The U.S. equity markets downplayed trade concerns and celebrated positive news as the Russell 3000 posted an impressive 7.1% quarter gain. The markets continued resilience is directly correlated to the surging S&P 500 earnings which have been strengthening throughout the year. Annualized operating earnings were up 27% in the first two quarters and they are expected to rise 28% year over year at the end of the third quarter. Although company buy backs are helping boost this metric, the majority of the corporate strength can be directly attributed to increasing revenues and exceptional profit margins.
The Index of Small Business Optimism increased in August to 108.8 and marked the highest index reading in its 45 year history as business owners reflected on job creation and favorable company expansion plans. Another positive uptick in the forward economic leading indicators supports further expansion. This expansion is also evident in job growth which remained strong in the quarter even though only 134,000 jobs were added September as the unemployment rate ticked lower to 3.7%. Assuming the trade talks and political risks don’t derail overall growth, the markets should continue to march in the direction of actual earnings and projected forecasts.
International Equity Markets
Under the weight of a healthy U.S. dollar, International developed equity markets posted a modest gain of 1.4% for the MSCI EAFE. Although trade tensions weighed more heavily on International markets, overall returns in local currencies were mostly positive before converting to U.S. dollars. Japanese equities returned 5.9% with the help of a weaker yen and Prime Minster Abe’s successful re-election. As Japanese banks continued to expand credit, available jobs in Japan reached their highest level since 1974. European equities lost further ground at the end of the quarter after Italy’s coalition government agreed to a much more aggressive deficit spending plan. Although Italy’s 2.4% deficit spending plan is within the European Union deficit targets, it was higher than expected and could to lead to bond rating downgrades. Eurozone business confidence continued to deteriorate in September for the ninth consecutive month as manufacturing slowed along with Europe’s exports as they dealt with further uncertainty surrounding future trade deals. MSCI emerging markets lost 1.1% under the influence of tighter U.S. monetary pressure. As a result of global trade tensions, China imported less to support local demand which seemed to penalize the eurozone most. As the markets continue to work through the trade negotiations, both developed and undeveloped international markets look even more attractive from a valuation perspective. Valuations are now at a 23% discount to U.S. equities compared to their historical average discount of 10%.
Fixed Income Markets
Safety-minded investors experienced flat results as the closely watched Barclays Aggregate rose 0.02% during the quarter. After the Fed raised rates in September for the third time in 2018, the 10-year Treasury drifted from 2.85% on June 30 to 3.05% on September 30. As the U.S. economy strengthened, the Fed felt it was necessary to continue the gradual tightening cycle without any end in sight. Given the slight overall yield increase at various maturities, the underlying government indices barely moved with the exception of the longer dated maturities. The Barclays US Government Long posted a -2.82% quarter loss, Intermediate -0.11% loss and Short 0.20% gain. In the international fixed-income arena, the JPM Non-US Unhedged lost 2.40% under the weight of the U.S. dollar advance. The Barclays Municipal lost 0.15% as investors refocused their attention on the positive tax advantage of this asset class.