2Q18 Market Overview
Instability continued throughout the quarter as trade tensions with China overshadowed more favorable economic news. Although the rhetoric heightened fears of an all out trade war, we feel it is important to keep in mind that the enacted tariffs of $81 billion are only a fraction of the threatened tariffs.
Fortunately, our diversified investors looked past the trade concerns and took advantage of market dislocations that the fears created. Our asset allocation approach to minimize risk and take advantage of less correlated securities helped our investors benefit from a few areas of the market that have been ignored lately. Both U.S. small cap equities and REIT’s were up nearly 9% in the quarter since they are relatively sheltered from the trade anxiety compared to the large U.S. global national companies.
As we progress further into the year in anticipation of two additional interest rate hikes, we should continue to benefit from the late stages of this nine year U.S. economic expansion. 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 needs. Given the 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 overcame trade concerns and recovered in the second quarter with the Russell 3000 posting a 3.9% gain. The markets continued resilience is directly correlated to the surging S&P 500 sales and earnings which have been strengthening throughout the year. The Index of Small Business Optimism increased substantially in May to 107.8 and marked the second highest index reading in its 45 year history. This favorable reading along with a positive uptick in the forward economic leading indicators supports further expansion. This expansion is also evident in job growth which remained strong in the first half of the year according to the U.S. Bureau of Labor Statistics with an average monthly gain of 208,000 as the unemployment rate rose slightly to 4.0%. The fundamental driver of the continued positive market performance will depend on earnings guidance. As we await the second quarter earnings, expectations are high since this is the second time in the past thirty quarters that analysts revised their forecasts higher in anticipation of strong results. Assuming the trade talks and political risks don’t derail overall growth, the markets should move higher, especially after the midterm elections in November.
International Equity Markets
Under the weight of a robust U.S. dollar, International developed equity markets posted a quarterly loss of 1.2% for the MSCI EAFE. Although trade doubts weighed more heavily on International markets, overall returns in local currencies were generally positive before converting to U.S. dollars. Eurozone equities were a bright spot since GDP growth held steady at about 2% (down from nearly 3% in the prior year). This growth rate reduction should provide European policymakers with a more gradual timetable in removing stimulus. Japan’s economy on the other hand is only growing at a 1% rate, however, their equity market also eked out a positive return. The trade tensions particularly hurt Japanese automakers since auto exports represent such a large portion of Japan’s trade balance. MSCI emerging markets couldn’t overcome the U.S. dollar strength and lost 8.0% during the volatile quarter. The escalation in global trade tensions hit China and other emerging economies hardest as investors adopted a risk aversion approach. Since 80% of the Chinese stock market consists of individual versus institutional investors, retail investors started selling in June before China’s state asset regulator stepped in to circumvent further downside pressure. As the markets continue to work through the trade negotiations, both developed and undeveloped international markets look even more attractive from a valuation perspective given the U.S. dollar advance.
Fixed Income Markets
Safety-minded investors experienced mixed results as the closely watched Barclays Aggregate lost 0.16% during the quarter. After the Fed raised rates for the seventh time since late 2015, the 10-year Treasury drifted from 2.74% on March 31 to 2.85% on June 30. On the surface, it appears that it was a quiet quarter. A closer look reveals heightened monetary policy risks as the 10-year yield peaked at 3.11% on May 17 before retreating by the end of June. Given the insignificant overall yield increase at various maturities, the underlying government indices barely moved. The Barclays US Government Long posted a 0.26% quarter gain, Intermediate 0.06% gain and Short 0.21% gain. In the international fixed-income arena, the JPM Non-US Unhedged lost 5.02% under the weight of the U.S. dollar advance. The Barclays Municipal gained 0.87% as investors refocused their attention on the positive tax advantage of this asset class.