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Market Commentary 06/30/2018

Navigating Headwinds                                                                                                                               

At the end of 2017, the consensus of many forecasters for 2018 was for volatility to return, interest rates to stay low, global growth to remain strong, the dollar to remain stable at the low end of a three-year range, and tax reform to boost economic growth.  Year to date, tax reform has boosted corporate profits and volatility has returned, however so much for the rest of the 2018 economic forecast.  According to Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist at Charles Schwab & Company, broad global economic and earnings growth continues, but the momentum is slowing.[i]  Considering all the volatility that returned during the 1st quarter after a fifteen-month hiatus, the second quarter stayed relatively flat for investors.  The Dow Jones Industrial Average was down 0.73% and the broader S & P 500 ended up 2.65% year to date.

There were many twists and turns during the quarter, not only in the markets but also in investors’ minds.  Geopolitical issues on trade tariffs and rising interest rates at home as well as abroad sparked volatility in fixed income, technology, developed international and emerging markets.  Why are the broader markets not down more significantly?  U. S. corporate earnings boosted by tax reform have offset some of the volatility.  Although the economy is slowing, it’s still growing in the U.S.  The fundamentals are strong globally, yet global economies are slowing with the unwinding of various forms of stimulus abroad. Therefore, some global economies are showing some disconnect in 2018 due to the above-mentioned headwinds.

Tariffs (border taxes charged on imported goods) are only part of the 2018 headlines.  They have been imposed on imports (with exception to certain countries) of lumber, washing machines, solar cells and modules, steel and aluminum.  Understanding who benefits and who gets hurt by tariffs is mixed.[ii]  According to Andy Rothman, Investment Strategist at Matthews Asia, the tariffs will only be levied against about 2% of all Chinese exports, since the Chinese economy is no longer export-driven.  Likewise, only 1% of all U.S. goods exported are affected.  These are small numbers in the bigger picture, yet investors have reacted by pulling out funds from international and emerging markets in anticipation of a full-fledged trade war.  When there is dislocation due to disruption, opportunities for investment become available. We continue to believe that the underlying story in emerging markets (EM) remains strong and we continue to add to EM while others are reacting.  Although EM are down the first half of the year due to the strengthening dollar, rising interest rates and trade tariffs, the EM consumer is very much alive. For example, the middle class has gone from 0% of India and China’s populations in 1994 to 12% and 30%.[iii]  Over the next twenty years, this number is set to grow to over 70% in many EM countries, so short-term volatility doesn’t reflect the case for EM.

Rising interest rates are also on many investors’ minds.  Over the past thirty-plus years we have enjoyed a bond environment that was the perfect storm.  Interest rates had fallen in the early 80’s from double digit to the lowest in our country’s history.  With the Fed continuing to tighten monetary policy and the economy now in late-cycle, investors will need to continue being selective within fixed income.  No one is calling for runaway rates or runaway inflation.  However, investors must rethink their bond strategy to maneuver through this adjustment from low yields to higher yields.  We continue to believe that keeping the duration shorter will provide more downside protection as rates move up.  Since we use bonds in our strategies as a ballast to the portfolio, principal preservation is weighted higher than seeking the highest yield.  We will be adjusting bond duration and seeking higher quality bonds in our bond allocation throughout the remainder of the year.  We will also seek out bonds and strategies that lend to the changing sector.  The Federal Reserve has indicated two more increases this year and possibly 3-4 next year.

Having the patience to wait near the sidelines with less yield will provide opportunities to extend our duration in the future as rates stabilize.

Although the days of easy money in our global markets is over, a new era begins ever so slowly as rates begin to rise and central bank infusions return to more normalized practices.  Over the past year we have taken profits in this now ten-year bull market.  The bull market party may not be over yet, but now it’s time to rethink our asset allocations.  We continue to discuss the importance of diversification to help smooth out the bumps.  Now it’s time to roll up our sleeves and dig deeper into the portfolio to identify where your risk exposure lies and align that with your long-term investment objectives.   Benjamin Graham, author of The Intelligent Investor, said:

“The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go.” 

We continue to believe in the strategies we have discussed with you through a diversified portfolio.  We look forward to our conversations with you and welcome your questions or concerns.  Enjoy the summer months ahead and relax.


Thomas L. Menzel, CFP®                                             Laura A. Biermann, CFP®


[i] Source: Schwab.com, 2018 Global Mid-Year Outlook: From Sugar High to High Tariffs? Jeffrey Kleintop, June 25,2018
[ii] Source: CEIC, Matthews Asia Perspectives, Andy Rotham, Investment Strategist, “Our Views on the U.S.-China Trade Dispute”
[iii] Source: J.P. Morgan Asset Management, “What is going on with tariffs?”  contributor Gabriela Santos


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