The second quarter of 2018 has come to an end. In my first quarter update, I reported that the market news was mixed. The growth in the stock market stalled in January and declined to the lowest point of the year as the first quarter was ending. Since then, the market has rebounded slightly. The performance in the second quarter saw the S&P 500 rise around 2.88%, though the gains for the year are only 1.67%.
These numbers are dismal compared to the growth seen in 2017. The S&P 500 rose 19.42% last year. This was a continuation of the strong economic recovery seen since the Great Recession ended. Growth was also helped by the tax and regulatory cuts the Trump administration proposed.
Fundamentally, this year should have been no different. Our economy is in relatively good shape and we appear to be entering a strong earnings season. However, concerns about economic policy seem to be driving investor sentiment.
Leading these concerns are the tariffs the Trump Administration has put into place. These tariffs were a dual edged sword during the quarter. GDP growth was the highest since 2014. The 4.1% increase sounds good until you understand that the growth is mostly attributed to China purchasing soybeans ahead of the tariffs going into effect.
For the most part, history has shown trade wars have a detrimental impact on all who participate. Other concerns include the fact that the strong dollar is making imported goods more expensive, rising interest rates, and the deregulation of financial industry safeguards.
There is no way to know how all of this will impact the markets. The prevailing attitude from Washington seems to be that, despite what history shows, the economy will benefit from these policies. Given the flat stock market, investors don’t seem to be convinced. We know that all economic expansions end eventually. We also know that the new tax cuts will leave the government deeply in debt and unable to put forward spending projects that could help elevate the nation out of the next recession.
Rather than worry about potential negatives, our focus is going to remain on achieving the financial goals we have planned for. The investment allocations recommended to my clients are based on two main factors: timeframe and risk tolerance. Over the last few months, I’ve sent Investment Policy Statements out. It’s a good time to review that if you’re worried about the direction the market is heading.
For my part, I’ve checked to ensure that the investment allocations of the portfolios I manage match with the risk profiles of each investor. Quarterly rebalancing took place in retirement accounts at the end of June. Investments in non-retirement will be reviewed at year end and rebalanced in a tax efficient manner. Rebalancing helps reduce market risk during a downturn.
As for the investment funds used in the process, I select them based on several criteria. A primary concern is ensuring that the funds have a low expense ratio. The lower the investment cost, the higher the rate of return. I also want to ensure that your investments will remain consistent. If an investment strays too far from its strategy, a replacement will be found. Fund management is also important. The fund manager must maintain consistent performance, and alternatives will be reviewed if there is a change in the management team.
Finally, all investments are compared to their peers within their class. If a fund consistently falls below the average, a better performing option will replace that one. As of the end of the quarter, 81% of the funds in my investment process have met or exceeded their benchmarks. A total of 40% of the investment options were tracking far above their industry benchmarks.
A Look Ahead
Aside from concern over tariffs, the markets are also facing what is known as an inverted yield curve. That’s when short term debts start offering higher yields than longer term ones. Almost all recessions begin 6 to 24 months after the yield curves invert.
On the other hand, another leading indicator, the Dow Transportation Index, has held strong over the last 10 months. Large transportations companies saw an upswing during the second quarter, yet concerns over a downturn pushed the transportation company Paccar (PCAR) down 30% during the same timeframe.
Unfortunately, no one can predict what will happen next. I would anticipate the market to continue along the same trajectory as before, though who knows what major event could move the markets next. The best advice I can give about the future is to remain cautious.