Resiliency Despite Headlines – Market Notes for Week Ended 7/13/18

For the first time since early March, the S&P500 managed to move back above the level of 2800.  This is a notable achievement against a backdrop of noisy headlines that include an escalating international trade war and a Federal Reserve board that seems to be saying it remains committed to tightening monetary policy at a pace faster that what its own longer-term view of the economy would call for.   Yet while domestic markets are behaving kindly, international charts (both economic and financial markets) can only be characterized as weaker.

From a fundamentals perspective, the US economy continues to appear quite good.  It is projected that real (after inflation) economic growth will exceed 4%, unemployment remains low with job market participation rising, and business optimism elevated; all at the same time as inflation albeit warmer does not appear to be running away.  Corporate earnings season also kicked off this past Friday, and 2Q looks set to be another quarter in which year-over-year growth will exceed +20% for the S&P composite.  Against a stock market that is only modestly positive for the YTD, stronger earnings means domestic valuation multiples are no longer near as rich as throughout 2017; that should provide some comfort to those most focused on the market seeming expensive.  Abroad however, financial market behavior suggests investors believe foreign countries will be the biggest losers from trade friction and a stronger US dollar.  China’s equity markets are off roughly 20% YTD; European equities are also notably lower from where they concluded the year making international exposure in portfolios a weight when benchmarking against domestic-only indices.

Looking forward, it is noteworthy that the calendar is historically no friend for the next couple months from a seasonality perspective.  That is especially true during mid-term election years (such as this) in which performance tends to be 4Q loaded.  Calendar aside, the proverbial wall of worry finds itself with no shortage of bricks stacked.  The US yield curve continues to flatten and inch ever closer to inversion, historically a recessionary omen.  Fresh trade war and tariff headlines seem to now be a staple in daily business news publications.  With how long and often those worries are being cited however, they should be at least somewhat baked into current prices.  International, suffering noteworthy capital outflows, seems overdone relative to actual economic softness.  We also recall that recessions typically begin with rising interest rates and oil prices; also both arguably evident after certainly not being the case in recent years.  All of these merit close attention but it is hard to get a recession when corporate earnings are still expanding.  Interesting, many of the same conditions present (including flat yield curve) today were existent in both 1984 and 1994 with a relatively mushy stock market experience accompanying them; but in both situations the years ended up being pauses that refreshed positive momentum the following year.  Whether history will rhyme remains to be seen.  Whatever the resolution to this confusing backdrop is for the markets, we believe one must continue to participate, but are be prudent to do so in corners of the market that tend to play better defense.  We have been evolving portfolio structures for some time with that perspective.

Posted in Blog Post.