The S&P 500 index started the year strong, rising the first few weeks, followed by a 10% decline. Since then, equity markets have been choppy while trending higher and most U.S. stock indices were back in positive territory for the year-to-date as of the end of June. We know that longer term price moves reflect changes in the fundamental value of an investment, while short-term price swings are largely driven by emotions and how investors are reacting to the uncertainties about the future. Others may also be influenced in their thinking by moves in the market itself and how they are feeling, with some wondering if we are in the later stages of the bull market.
Economic growth over the last year has been strong. U.S. corporate profit growth exceeded 20% and is much higher than expected, benefiting from the tax cut and jobs act passed last year. The growth of the U.S. economy has resulted in approximately 200,000 new jobs each month and the unemployment rate has continued to decline to the current level of 4%. Various measures of consumer sentiment have improved and the NFIB Small Business Index has increased sharply which could lead to increased capital spending and other growth and technology initiatives. Most economies globally are seeing improving growth rates, but many remain skeptical and wonder if these trends can continue.
Tariffs and the potential disruption in global trade are among the most worrisome clouds on the horizon. U.S. businesses are expressing more concerns about the uncertainty of international trade policy, but most outlooks for near term growth are still generally upbeat. U.S. manufacturers are concerned about the effect of tariffs on their costs. Several contacts in the farming sector have expressed unease over the potential impact of international trade policies, even as the outlook for farm income for 2018 has been brightening. Trade talks with China have stalled as Chinese President Xi seems to be blocking a trade deal, but there is still the possibility that something will get done there, as well as with our other trading partners.
Rising interest rates and Fed policy are potential risks to the economic outlook. At their June meeting, the FOMC increased the federal funds rate to a range of 1.75% to 2.00%. With the strength in the economy and employment and inflation moving above the Fed’s long-term goal of 2.0%, the Fed now expects to raise short-term rates twice more this year and three times in 2019, and will probably continue to gradually reduce the size of their balance sheet. We believe the Fed will be flexible to any changes in the economic environment and that this reduction in monetary stimulus is unlikely to disrupt the economic expansion.
The flattening of the yield curve has also received much attention recently, with some wondering whether this is a signal of an increasing chance of a recession. High real rates and an inverted yield curve, where short-term rates are pushed higher than long-term rates, are leading indicators of economic downturns. However, real rates today are close to zero and the yield curve is not inverted. We believe the evidence points to continued economic growth.
The trade-weighted value of the U.S. dollar has been rising again, reflecting the relative strength of the U.S. economy and the higher rate environment. This has proven to be challenging for bond investors with extremely low rates and narrow credit spreads beginning to rise. Even so, the Fed doesn’t want to see too much further strength in the dollar and with other central banks remaining very dovish, it seems likely that the upward movement in rates over the next year will be limited.
There is no shortage of things to worry about and the negative short-term impact is being felt in international markets. In addition to the trade issues, Europe continues to battle ongoing political disputes, but recent economic trends seem to be improving, while Japan is showing slow but steady growth. Some emerging market economies are in trouble, but better growth is expected in India and China. This suggests that the synchronized global growth story will continue into 2019 and better equity valuations may provide investors with attractive opportunities.
In the conclusion of his widely acclaimed biography of Leonardo daVinci, Walter Isaacson, professor of history at Tulane University, offered some lessons that we can all learn from Leonardo’s life. He wrote that we need to be relentlessly curious as critical thinkers, to seek out and have respect for the facts, collaborate, take notes and make lists. At Whitnell we strongly believe that investing is inherently logical, even though over the short term it may seem otherwise, and long-term investments can be made even though nobody knows exactly what will happen in the future.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form or referred to in any other publication, without express written permission.