1 Q 2018 Commentary

- 2018 1st Quarter


Global Markets: Optimistic

International Markets continue to be the most favored area of investment for the first quarter of 2018 and looking forward for the next 12 months.  The best performing asset class in Q1 was emerging markets.  With P/E ratios in the 13-14 times range, performance in developed international markets appears to be poised for strength.  This is further supported by projections of increasing quarterly earnings across the board.  The weakening dollar should also support a favorable environment for international stocks.  Finally, global manufacturing demand, especially in developed markets, is very strong.  This is generally a leading indicator of economic performance in the near term.

 

 

U.S. Economy – Very Good, for now

While the U.S. stock and bond markets have been less than terrific so far in 2018, the economy continues to be strong.  The markets and the economy often move in different directions.  Unemployment is hovering at 4.1%, with some level of wage inflation.  Housing demand continues to increase.  There has been a manufacturing push which has built up inventories over the last 3 months anticipating consumer demand.    The biggest thrust toward short term growth has been the 2018 tax cuts.  They have an immediate effect on earnings for U.S. companies.  Economists generally agree that the consumer will also find more money in their pockets through the tax filing season in 2019, which represents a huge force to keep our economy lifted.  The consumer accounts for nearly 70% of GDP.  The caveat is that the effect of the tax cuts may prove to be short lived.  Once the stimulus is priced in, there’s nothing to come behind it except growth, to push earnings up above 2018 levels.  In addition, the abnormally low unemployment rate could slow things down, as businesses choose to just hold their size rather than hire a more expensive worker to spur growth.

 

Inflation – Good, projected to stay low

Inflation continues to hover around 2%, projected to move up slightly in 2018.  The 2 key drivers are energy prices and labor costs.  Normal wage inflation sits at about 4%, but the U.S. is still somehow in the 2.5% range.  That should move up as demand for workers exhausts the supply of workers who are on the sidelines, or are moving up the employment ladder.  While energy prices are not directly measured as a factor of inflation, they are embedded in every other factor.  Higher oil prices mean more expensive manufacturing, shipping, and cost of operating a business.  At some point that must be passed onto the consumer.

 

Interest Rates – Neutral, with caution

Chair Yellen was replaced recently with Fed Chair Powell.  While Powell appears to be cut from the same cloth as Yellen, he has made it more firmly clear that he intends to raise rates this year and next, a total of at least 6 times.  Remarkably though, more members of the Federal Reserve Board than in the past are interested in seeing rates pushed up more aggressively, possibly 4 or more times in 2018 alone.  As such, the signals are clear that there is a plan to attempt to normalize, which means all rates go up, and bond products will present greater than average volatility and risk to the investor.

 

U.S. Stock Market – Good with Caution

The first quarter gave us much higher volatility than we have seen in the last 2 years, including one 10%+ downturn, and four 5%+ downturns.  In each case the market rebounded, with much nail biting.  Volatility does not necessarily signal a protracted downturn in the markets however.  We have become used to lower volatility and markets that only move up, making these last 3 months even harder to tolerate.  However, 2 factors have pushed forward P/E’s into the normal range, making stocks appear much more reasonably priced than just a few months ago.  First, many prices have moved down and have not rebounded.  More importantly, earnings are looking much more promising over the next 12 months due in large part to the tax cuts.  With the reshuffling and brighter short term outlook in mind, and the strong underlying economic state of affairs, the U.S. Markets look favorable for the next 12 months.

 

Allocation Comments

Allocations were held firm for the last few months in both the AdviseMe and High Dividend ETF Portfolios.  However with a bias towards dividend paying stocks in the ETF portfolio, and an allocation to more value oriented positions in the AdviseMe models, the portfolios underperformed.  It is worth noting that performance in 2017 was highly concentrated in just a handful of stocks, and has skewed what investors should look for in their own well allocated portfolios.  This does not reveal a flaw in the security choices in these allocated portfolios, given the long term outperformance of value over growth, and the tendency for value to come back into favor as yields increase.  Keep reverting to good risk appropriate asset allocations, and be patient for the markets to behave more normally.

YTD 2018 Total Return data sourced from www.Morningstar.com , www.MSCI.com


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