Quarterly Commentary – September 2018

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The U.S. Equity markets continued their upward move during the quarter. Year to date the results have been good for U.S. equities but not very good for international equities nor fixed income. The following are performance numbers from various popular indexes. Please remember index numbers are not individually comparable to a properly diversified portfolio. Each portfolio may include an allocation to securities similar to these indexes in varying amounts based on your personal risk tolerance and should only be compared in that context. The S&P 500 was up 10.6% for 2018. The Dow Jones Industrial Average was up 8.8%. The Nasdaq Composite Index was up 17.5%. The Russell 2000 Index was up 11.5%. International equities as represented by the MSCI AC World Ex U.S. Index were down 3.1%. The MSCI Emerging Markets Index was down 7.7%. Fixed Income as represented by the Barclays Aggregate Bond Index ended down 1.7% for the year.

The US equity market is enjoying one of the longest bull market in history. Aside from a possible short term correction, there doesn’t appear to be anything obvious around the corner that might derail the secular nature of this bull market. The significant increase in earnings have allowed valuations to remain within historical norm so we are not looking at an overheated market by historical standards. Earnings for 2018 are expected to remain very strong, having benefited from the prolonged economic recovery, a less burdening regulatory environment and substantial tax cuts.

The economy is growing at a strong pace, business optimism is near an all time high and capital expenditure spending plans are solid. Consumer spending is strong and is expected to remain that way through the rest of the year. Company earnings which are a significant component behind driving stock prices higher have been quite strong with very positive expectations for the rest of the year and into 2019. Inflation in the US has hit the 2% target set by the Fed which is relatively benign. During a prolonged low unemployment environment, there are risks of inflation rising sharply, however what seems different this time is that there is slack due to labor force participation that reflects more spare capacity than in prior times.

This year, most of the S&P’s 500 performance is explained by very few sectors doing very well indicating declining breadth. Breaking down the Index by Bloomberg sectors, the disparity of returns is evident with only 2 sectors (Technology and Communications) doing very well and the rest of the sectors (Industrials, Materials, Financials, Utilities, Consumer, Energy) not doing as well as the index. In other words, not all areas of the market have done as well. To expand on the disparity, ten companies in the S&P 500 contributed to over half of the return for the index.

It is important to keep in mind that in a diversified portfolio, allocations to international and fixed income would have caused the performance of the portfolio to be lower than an all US Equity portfolio. Diversification is however sound and necessary over time to reduce risk. Furthermore, predicting which areas will outperform in the short term is not possible.

On the less positive side of things, housing is slowing, financial conditions are becoming less accommodative in face of trade war speculations. Adding to that is the Federal Reserve having just raised rates and the expectations are for another raise in December. The rate increase can be viewed as a positive in that the economy was deemed on strong enough footing to withstand it but can present headwinds in the face of the trade uncertainty. Trade tensions and imposed or threats of tariffs are a potential drag on global consumption. The trade dispute comes at an inopportune time when China had begun to take control of its credit growth and reduce leverage after years of loose domestic lending. With stricter financial regulations there are worries of an economic slowdown by China and possible global repercussions. Although we always have to contend with geopolitical risk, the index that tracks the metrics related to such risks has recently trended lower.

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