Global Markets: Optimistic with Caution
International markets had a terrible year, with the MSCI EAFE performing worst among the indices we track. The malaise and never ending uncertainty in Europe, with Brexit remaining unresolved, and pockets of unemployment festering, the corporate earnings results never have a chance to shine. Emerging markets dove into deep value territory with historically low P/E’s as well. Non–US equity markets, which make up 50% of all markets, continue to look over corrected versus their earnings, and outlook.
U.S. Economy – Very Good
The U.S. economy continues to stay in very healthy territory. Unemployment has stayed below 4% for many months while not showing the feared effect that an undersized labor force would have on productivity, and only showing mild wage inflation. Housing demand has slowed somewhat, but continues to run ahead of supply in many markets. Even inflation has stayed safely in the 2% range, dipping slightly below recently, perhaps instigating the more doveish tone of the Fed.
Corporations are starting to report earnings past the impact of tax cuts, with solid results. Fourth quarter retail sales online were excellent, while bricks and mortar still struggle to find their way. We say a year of iconic brands like Sears and Toys “R” Us shuttering their stores. Financials have shown some strong results from the rise in rates, and increased credit us. Technology had some bumps in the fourth quarter, but all in all remain strong. Fuel prices remaining moderate to low have put money in the pockets of average workers who are choosing to spend and not save that extra cash.
There is very low likelihood of recession in the next 12-24 months as measured by economic factors.
Inflation – Low
Inflation ticked down slightly in the 4th quarter. While there has been some wage inflation, it is only slightly above average, meaning the feared runaway inflation from labor shortages has not occurred. Alternately the lowest earners are not seeing the increases in wage needed to lift the, up economically. 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, and lowered guidance for a target rate by .25%. The market reacted favorably to this announcement. Powell will likely still advocate to increase rates through 2020, but there will be fewer increases. As a result the bond market has shed some of the earlier pressure and should be less volatile. 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
U.S. markets through December 31 delivered negative results with sharp reversals in the FANGMAN stocks. A rotation to value, which began to occur in the new year, may yet continue to unfold. The increased volatility of Q4 should quiet in the first half of 2019 as investors remain cautious, but search for value.
Catalysts to volatility will be political unrest, earnings reports, activities in Asia related to trade, and Europe.
While international has been a severe 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 2018. Do not let the fear that bubbles up during periods of volatility allow you to diverge from your allocation. Rebalancing during a downturn is a powerful predictor of good long range results. Keep reverting to good risk appropriate asset allocations.
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