Market Watch - October 2018
We are pleased to provide you with our quarterly newsletter featuring the status of our investment class weightings, our interpretation of recent data and our outlook for the future. If you have any questions about any topic, we hope you will not hesitate to contact us.
Status of our Investment Class Weightings
Changes from our July 2018 Market Watch are noted in italic.
US Large Cap Sectors –
Overweight – Health Care
Neutral – Communication Services (New), Consumer Discretionary, Energy, Financials (↓), Industrials, Information Technology and Materials
Underweight – Consumer Staples
No Weighting - Utilities
US Mid and Small Cap – Maintain all weightings.
International Developed Markets – Maintain all weightings.
Emerging Markets – Maintain all weightings.
Alternative Strategies – Maintain all weightings.
We will continue to target an average fixed income portfolio duration of 5.88 years (or less), the current effective duration of the Barclays US Aggregate Bond Index.
Multi-sector Bond Funds – Maintain all weightings.
Investment Grade US Corporate Bonds – Maintain all weightings.
Convertible Bonds – Maintain all weightings
High Yield US Corporate Bonds – Maintain all weightings.
Investment Grade Municipal Bonds – Maintain all weightings.
Data – During Q3, the US equity markets rose throughout the summer in the face of the intensifying trade conflict. For 2018, we see the following benchmark returns: US Large Cap – DJIA (+7.03%) and S&P 500 (+8.99), US Small Cap - Russell 2000 (+10.40%) and International - ACWX (-4.52%). Economic data during Q3 was generally good. GDP, the broadest measure of economic output, for Q2 showed an annualized growth rate of +4.2%, which followed slower growth in Q1 (2.0%). Volatility (as measured by VIX) remained low during the quarter finishing Q3 at 12.12, well below the long run average of 20.0. The Conference Board in reporting the August LEI (Leading Economic Index) said that “the leading indicators are consistent with a solid growth scenario in the second half of 2018 and at this stage of a maturing business cycle in the US it does not get much better than this.” During the quarter, the yield on the benchmark 10-year US Treasury jumped from 2.85% to 3.06%. Monthly job growth averaged 198,000 in June, July and August as the national unemployment rate remained a low 3.8%. New weekly unemployment claims fell to a 50-year low in early September and averaged 211,916 in Q3, compared to 222,833 in Q2. Consumer confidence, as measured by the Conference Board, reached a 2018 high in August after falling in the spring from the previous high level recorded in February. The September Manufacturing Outlook survey (Philadelphia Fed) reported that “broad indicators for general activity, new orders, shipments and employment looked positive and that while expectations for the next six months remained optimistic, most broad indicators showed some moderation for the remainder of 2018.” Inflation, as measured by the change in the Consumer Price Index, came in at 2.7% in August and remained above the Fed target of 2%. Retail sales were strong in July and then disappointed in August during the critical “back-to-school” shopping period. Weak single-family housing starts, lower new home sales, a drop in building permits, rising mortgage rates and fading homebuilder sentiment could be pointing to trouble in the housing sector.
Outlook – When the equity markets fell in February much of the reason behind the sell-off was the prospect of rising interest rates. As we head into the final quarter of 2018, we now view rising rates more as a reflection of a stronger, growing economy. At its September 25/26 meeting, the Federal Open Market Committee (FOMC) raised its benchmark interest rate by 0.25% to a range between 2% and 2.25% representing the highest level since April 2009. The hike, which was widely expected, was the third hike in 2018 and the seventh increase since the bank cut its rate to nearly zero during the 2008 financial crisis. The Fed remains on track to continue with gradual interest rate hikes projecting one more hike in 2018 (most likely in December), followed by three additional hikes in 2019. The most notable change in the recent Fed statement was the removal of language indicating the Fed sees its policy as accommodative. We must assume that the removal of this language signals that Fed officials see their current interest rate policy as nearing the level that is needed to sustain full employment while meeting the Fed inflation target of 2%. At his press conference Fed Chairman Jerome Powell said “that since we met in August the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly. Inflation remains near 2% and the indicators for longer-term inflation expectations are little changed, on balance.” While we acknowledge that, thus far, the Fed has maneuvered along the tricky path of interest rate normalization quite well the potential for policy misstep will continue to be a risk to US stock price growth in the future.
While improving economic growth and strong consumer sentiment should move the equity markets higher, there remain several issues that could slow or derail any market climb. The ongoing trade conflict has not as yet had much impact on US economic growth. That could change as we head into the all-important holiday season. The pending agreement to revise the North American Free Trade Agreement (NAFTA) will be welcomed by investors as a sign that the Trump administration is willing, at some point, to agree to new trade deals. It will also allow investors to be more patient with what could be a long wait for the completion of a trade deal between the US and China. In the interim, US trade negotiators can now focus more on completing deals with the European Union and Japan. Inflation, which reached a 5-year high of 2.9% this summer, is unlikely to move much higher as price pressures remain relatively modest and wages continue to climb slowly. The midterm elections should add to market volatility in the weeks leading up to November 6th as analysts consider how the Trump pro-business agenda could be impacted if Republicans lose control of the House (possible) or Senate (less likely). A loss of control in the House may imperil additional tax reform, but may also offer a counterweight to the aggressive approach to trade undertaken by the Trump administration. Once all the votes are counted there may be some good news for investors as the S&P 500 Index has risen in every 12-month period following a midterm election since 1946.