Global Markets: Optimistic with Caution
International Markets rebounded somewhat in the 1st quarter, but not as strongly as domestic markets. The reasons remain the same for the underperformance: Brexit, trade wars, and uncertainty. Europe still suffers from pockets of high unemployment. The Brexit discord continues to leave many unanswered questions for the future of Europe. The U.S. and Chana still remain at odds over trade issues. These unresolved major issues are adding a risk discount to the markets. On the upside, the dollar has weakened and the U.S. Trade deficit has grown relative to the world, indicating that there should be some winners in trade with the U.S. Multiples on good international companies remain lower than results would suggest are reasonable.
U.S. Economy – Very Good
The story about the U.S. economy remains positive. Unemployment seems to have reached a trough just below 4% while not leading to horribly negative effects on productivity, and showing mild wage inflation, concentrated in certain areas of the economy. Fears about housing which were driven by rising interest rates have cooled, as interest rates seem to have stabilized. Inflation has stayed safely in the 2% range, with projections to stay low for the foreseeable future.
Corporations that reported earnings stripped of the tax cut effect buoyed the first quarter. Despite the government shutdown at the start of the year, the consumer seems to have resumed normal spending. With interest rates low and likely to stay low, the economy should continue to grow at a slow but steady pace.
There is very low likelihood of recession in the next 12-24 months as measured by economic factors.
Inflation – Low
Inflation remains just below the 2% mark. Wage inflation, feared to potentially create systematic inflation from labor shortages has not occurred. There are some continued individual corporate “minimum wage” announcements as companies fight over a thin work force. These may have some impact on earnings in the future. Inflation that hovers around 2% should be viewed as a favorable indicator of an economy that is healthy, and will help the Fed to remain cautious with rate increases.
Interest Rates – Neutral
Fed Chair Powell has slowed the pace of rate increases, with analysts predicting 0-2 raises this year and next. The market reacted favorably to this announcement. Powell is walking cautiously through the normalizing process, which the markets seem to like. With fewer increases on the horizon, the bond markets should be more stable than in a rising rate market. Durations can be moved back to normal ranges, but quality should remain high. Short term assets should be held in cash or money market.
U.S. Stock Market – Good with Caution
Markets are affected by many things: earnings, rates, geopolitical factors, sentiment, economic reports and more. Right now, in the U.S., many of the basic components of a good market are in place. Unemployment is low, inflation is low, interest rates are stable, and the consumer is spending money to buy goods and services. This should allow earnings to grow over time, and push the markets higher.
International has been a severe underperformer, but allocation to this asset class is still compelling based on good companies having attractive valuations. At some point, when Brexit woes are resolved and the trade talks with China lead to a better deal for the U.S and others, International should reward the investor for staying the course. It is also important to balance growth and value. Rebalancing after these recent swings will be very important to make sure that the swings we have seen in the last two quarters do not allow your portfolio to drift into higher or lower risk territory that will undermine your long term results.
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