Market Insights – Market Review and Outlook Q3 2018
Global Markets: Optimistic
Global markets continue to underperform, despite the undervaluation that has persisted for many months. Justifiable fears over trade skirmishes along with a general atmosphere of uncertainty, such as the resolution and implementation of Brexit, has continued to hold back a natural market recovery in areas that have improved economically, especially in Europe. P/Es for international stocks continue to be below historical averages, but markets have remained negative for the year. While a rally in International has not evolved, conditions seem favorable to support a neutral position in international, including emerging markets.
U.S. Economy – Very Good
The 3rd quarter continued the economic progress seen so far in 2018. This good progress was seen in the extension of a bull market through Q3. Unemployment hovered right at 4% softening fears that an undersized labor force would prevent productivity from growing or cause oppressive inflation. Housing demand continues to run ahead of supply. Inflation has stayed safely in the 2% range.
Corporations are starting to project earnings past the impact of tax cuts, with promising results. In particular, financials have shown strong results from the rise in rates, and appetite of the consumer and corporate America to borrow and spend. The share buybacks and M&A expected to result from the tax cut cash windfall have been seen increasing in pace. The consumer with more to spend or save is choosing to spend.
There is very low likelihood of recession in the next 12-24 months as measured by economic factors.
Inflation – Good, projected to stay low
While inflation has ticked up, it has done so at a slow rate. The fear of inflation running up quickly has not shown signs of being realistic in the near term. Some wage inflation is starting to percolate, but at a level that supports consumer spending, but does not damage corporate earning prospects. Inflation that hovers around 2% should be viewed as a favorable indicator of an economy that is behaving as it should.
Interest Rates – Negative
Fed Chair Powell has every foreseeable intention to normalize interest rates. Powell will likely advocate to increase rates through 2020, targeting a Fed rate of 3.5%. As a result the bond market will continue to be pressured. The yield curve, which threatened to invert or flatten has returned to a normal shape. Investors should be cautious with bond investments through the next few years. Durations should be kept short, and quality high. Short term assets should be held in cash or money market.
U.S. Stock Market – Good with Caution
U.S. markets through September 28 quietly delivered strong results but remained highly concentrated in the FANGMAN stocks. A rotation to value, which seems likely, has not been fully realized. NASDAQ and Small Cap markets led the way, but there seems to be an increased likelihood of volatility as investors remain increasingly nervous that the long bull market might be vulnerable.
Catalysts to volatility will be the mid-term elections, earnings reports, activities in Asia related to trade, Fed policy, and more. Investors are looking for clarity during a period that offers many data points to consider.
While international has been an underperformer, rebalancing to include the class remains important. It is also important to revisit the balance between growth and value in portfolios that may have drifted out of target ranges in 2017 and to date in 2018. Rebalancing remains the most powerful tool to support the risk management role of asset allocation and is most effective during periods when the market expresses volatility. Keep reverting to good risk appropriate asset allocations.
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