EQM Capital LLC – 2Q 2018 Market Review – Just Keep Swimming

Posted on Jul 3, 2018

After a year of placid calm and upwardly trending markets, volatility has come up for air in 2018. Markets have been reeling from severe volatility since February owing to inflation concerns and global trade war fears, as tensions between the U.S. and its major trading partners have escalated.

Trade tensions have inflicted damage on emerging market and Chinese stocks, and negatively impacted large U.S. industrial stocks and other industries heavily dependent on foreign trade. On the other hand, small cap and technology stocks have benefited, as they are somewhat insulated from trade concerns.

Despite rising uncertainty, the U.S. stock market was mostly positive for the quarter, and gains were pretty broad-based, with 7 of 11 sectors ending in positive territory. Corporate earnings were up a whopping 19% year-over-year on 8.2% higher revenues.  And thanks to tax-reform and positive earnings, 89 S&P 500 companies boosted dividends in the second quarter compared to 67 last year, with a record dividend payout of $124 billion declared overall.

So despite many destabilizing factors in the market, the market has shrugged them off and focused on the positives instead:

  • Tax Cuts Boosting Economic Growth – On Jun 13, the Fed raised forecast for 2018 GDP growth from 2.7% in March to 2.8%. A key catalyst behind these positive revisions has been tax cuts. The corporate tax rate was recently lowered from 35% to 21% and repatriation of income will be taxed 8% to 15.5%, instead of the current 35%.
  • Strong Job Market The labor market added 223k jobs in May, exceeding the consensus of 190k and the unemployment rate is the lowest in 18 years.
  • Economic ExpansionThe Institute for Supply Management (ISM) reported that the U.S. manufacturing index rose to 60.2% in June, up from 58.7% in May. The manufacturing sector accounts for 12% of the U.S economy.  A level above 50%, indicates economic expansion.

The negative-side of all this good news is it sparks concern about higher interest rates and rising inflation. The Fed raised interest rates in June and is expected to hike rates at least one more time by year end.  Interest-rate sensitive sectors such as financials, telecommunications, and consumer staples struggled during the quarter.  Fixed income investors have favored floating rate, short-duration, and inflation-protected bonds.

The market is in the late innings of a bull-market rally and the chance of recession is rising going into 2019. We recommend clients remain well-diversified and positioned for higher rates and inflation.  And while we continue to favor stocks over bonds for the remainder of the year, higher rates may at some point justify a flight to safety. But for now, keep your head above the water, and just “keep swimming”.

2Q 2018 Benchmark Performance

Target Risk 2Q 2018 YTD 1Yr 3Yr 5Yr
Morningstar Conservative 0.00 -0.85 2.33 3.24 3.24
Morningstar Moderately Conservative 0.39 -0.53 4.68 4.98 5.23
Morningstar Moderate 0.56 -0.31 6.92 6.41 6.92
Morningstar Moderately Aggressive 0.76 -0.03 9.33 7.82 8.60
Morningstar Aggressive 1.14 0.46 11.42 9.00 9.93
Benchmark Indices
Dow Jones Industrial Index TR 1.26 -0.73 16.31 14.07 12.96
S&P 500 TR (U.S. Stocks) 3.43 2.65 14.37 11.93 13.42
Russell 2000 TR (U.S. Small Stocks) 7.75 7.66 17.57 10.96 12.46
NASDAQ Composite 6.61 9.37 23.60 15.96 18.54
Barclays Aggregate Bond TR (U.S. Bonds) -0.16 -1.62 -0.40 1.72 2.27
MSCI EAFE (International) -2.34 -4.49 4.01 2.06 3.63
MSCI EM (Emerging Markets) -8.66 -7.68 5.81 3.23 2.61
Source: Morningstar as of 6/30/18

Disclosure

The opinions expressed above should not be construed as investment advice. This letter is not tailored to specific investment objectives. Reliance on this information for the purpose of buying the securities to which this information relates may expose a person to significant risk. The information contained in this article is not intended to make any offer, inducement, invitation or commitment to purchase, subscribe to, provide or sell any securities, service or product or to provide any recommendations on which one should rely for financial, securities, investment or other advice or to take any decision. Readers are encouraged to seek individual advice from their personal, financial, legal and other advisers before making any investment or financial decisions or purchasing any financial, securities or investment related service or product. Information provided, whether charts or any other statements regarding market, real estate or other financial information, is obtained from sources, which we and our suppliers believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Nothing in this letter should be interpreted to state or imply that past results are an indication of future performance.