August 2018
Market Update
(all values as of 07.31.2020)

Stock Indices:

Dow Jones 26,428
S&P 500 3,271
Nasdaq 10,745

Bond Sector Yields:

2 Yr Treasury 0.11%
10 Yr Treasury 0.55%
10 Yr Municipal 0.64%
High Yield 5.44%

YTD Market Returns:

Dow Jones -7.39%
S&P 500 1.25%
Nasdaq 19.76%
MSCI-EAFE -10.64%
MSCI-Europe -10.86%
MSCI-Pacific -10.53%
MSCI-Emg Mkt -3.21%
 
US Agg Bond 7.72%
US Corp Bond 8.44%
US Gov’t Bond 9.35%

Commodity Prices:

Gold 1,992
Silver 24.54
Oil (WTI) 40.43

Currencies:

Dollar / Euro 1.17
Dollar / Pound 1.30
Yen / Dollar 105.01
Dollar / Canadian 0.74

Manager’s Comments – August 27, 2018

As the Summer lingers on, I hope everyone is enjoying the season and perhaps a well-deserved vacation. Markets are often uneventful during the Summer months. 2018 will go down as an exception. While I would describe current market conditions as stable I also believe sentiment is growing more skeptical.  Here are some charts to support this opinion.

** Markets remain highly-valued. Despite the strong earnings trend, valuations are rich

CAPE stands for – Cyclically Adjusted Price/Earnings Ratio. It represents a leading, historic measurement of overall valuation. Its historic mean is 16. Although I don’t use the CAPE Ratio as a market-timing tool, its extreme level relative to its norm and other similar ratios can’t be ignored. And this indicator is useful in estimating longer-term returns, so I do view it as a potential warning.

** Inflation and Interest Rates are not an imminent threat to the economy or market

Gasoline prices and some producer input prices have risen. Trade and tariff disputes are minimally impacting business confidence. However, a strong US dollar coupled with minimal wage growth (despite low unemployment) are consumer tailwinds currently. This bears watching but for now, the inflation worry is low. Excepting China, I contend that improved trade relations are imminent.

 

 

This chart above shows short, medium and long interest rates converging throughout 2018. Often, a flat curve can imply pending recession. However, I see nothing to indicate imminent recession.  I believe two dynamics are driving the flat curve: 1) With low rates overall, income investors are taking increased risk in the long end (and equities); 2) With the negative Trade rhetoric toward China and in light of the recent Turkish currency collapse, capital is leaving many markets in favor of the US. Both trends are helping to hold longer rates in check.

**  Economic Conditions are Very Good

 

 

 

The preceding three charts individually and together powerfully display the US economy’s strength.  While job growth and corporate profitability may not improve much from here, there is little to suggest that either will weaken.  Seasonal factors may show a quarterly decline in some macro data but current conditions continue to support:    Growth;  Profitability;  Employment;  Spending;  Stability.

By reviewing just the primary macro inputs (as demonstrated with the earlier charts) of employment, inflation, interest rates and GDP, it is obvious that the US economy is strong.  It is also easy to conclude that this strength will continue.  And validation of a sustainable economy is a rising stock market.

However, as we’ve all observed, economic fundamentals have taken a back seat to political polarization and a very vocal and belligerent Trump administration. Due to the negative Trade rhetoric and Trump’s mounting political insecurity, the market’s Summer ascent has been a struggle and very difficult to trust.  There seems to be a crisis of confidence building.

In the May Newsletter I said:  “rising rates and Trump’s fate will be the biggest catalysts for heightened volatility.”  Indeed, the Federal Reserve Bank continues with a policy of slowly bumping up rates.  If not for the capital flight into the US, market rates would be higher than they are.  Clearly though, the direction of interest rates is up.  Slow and steady are preferable of course. As for Trump’s fate, I will not be surprised if the Mueller investigation wraps up just prior to the November mid-term elections.  Perhaps I’m too cynical – but it seems fitting that this political saga will climax then causing even greater uncertainty.  

We will continue to wrestle with the competing influences of strong fundamentals and corporate profitability on one hand -vs- the extreme noise of a highly contentious and potentially corrupt Administration on the other hand.  And let’s not forget that market valuations remain highly valued.

 

While the Trump Administration may advertise dubious victories (NoKo; EU Trade Negotiations; NAFTA Revision) to bolster public sentiment, it is doubtful any that we’ve seen thus far (other than the Tax Reform) has true market-boosting power. Resolution of trade disputes will lessen investor worries but resolution alone may not be enough to cause transformative growth …. after all, the trade penalties (tariffs and capital flows) haven’t been in place very long so the upside to resolution at this point is suspect. Tax Reform was and continues to help stock performance and future growth. But whether it alone can sustain 4+% GDP and sub 3% unemployment into the future is uncertain and improbable. These are unknowns currently. What is known is that the Mueller investigation is gathering steam and due for resolution soon. How this plays out will likely determine the 2018 outcome for market returns.

Therefore, I continue to refrain from an over-weight to equities although the domestic allocation is relatively overweight to the international allocation. Recently, I reduced Emerging Market exposure which should help performance relative to most account benchmarks. This was something I resisted all year long, but it finally became clear that the main target of Trump’s trade policies is China. And the Emerging Market space is heavily dominated by and dependent upon China.

Other than those accounts that must produce regular and sizeable cash distributions, the majority are at full-allocation subject to the US/International condition described above. I have also been more reliant upon preferred stock funds than previously due to their relative stability and income payout levels. Should volatility return in the Fall, these funds and other high-income alternatives should cushion potential portfolio declines.

From a return perspective, the Summer months of 2018 have been very good. Both the S&P 500 and the Dow Jones Industrial Average have risen approximately 6% since June 1st. And both stand at or near record highs.  Here is one additional chart showing the current bull market run against the previous record setting run. Neither was typical by most traditional measurements. The prior bull run ended with the Tech Bubble. Although I don’t foresee an immediate collapse of the current bull run I do expect future returns to be less robust than what has been achieved over the past two years.  Thank you for your interest.

Paul Scheu, Manager