Market Monitor & Recap

Market Recap

2nd Quarter Recap and Outlook - March 31, 2018 to June 30, 2018


President Trump's tough stance on trade continued to rattle markets and incite volatility throughout the second quarter. This is evident in the recent underperformance of both international developed and emerging market equities, with each underperforming the S&P 500 by 4.49% and 11.33%, respectively. In addition, U.S. small-cap stocks, which are more domestically focused, outperformed their large-cap peers by 5.34% for the quarter. Thus far the Trump Administration has imposed trade tariffs on everything from Canadian steel to Chinese made X-ray machines. In response, nearly all of the countries targeted by Trump have issued retaliatory tariffs; so far more than $34 billion of tariffs have been levied on U.S. goods.

Another significant geopolitical development during the quarter, one with positive implications for risk assets, was the preliminary agreement of North Korea to denuclearize. According to U.S officials, 2020 remains the best possible date targeted by which North Korea could completely denuclearize.

So far this year the S&P 500 has returned, 2.64%, which is in line with our expectation of a low-single digit return by year-end. Toward the end of the quarter, the investment policy committee decided to target our overweight allocation to equities down to 2% from 4%. This decision was predicated upon both the rich valuation of U.S equities and the committee’s view that the U.S. economy is in the late stage of its current business cycle.

On the back of increasing inflation, a strong U.S. Dollar, and stronger supply/demand dynamics, WTI crude rose 14% during the quarter. This helped to propel energy, which was the best performing sector in the S&P 500, higher by 13.5%. Technology stocks also performed very well, with earnings growing over 30% year-over-year for the first quarter.

During their June two day meeting, the Federal Reserve decided to raise the Fed Funds rate by twenty-five basis point, a move that was highly expected by market participants for months preceding the decision. Credit spreads consistently widened throughout the quarter, which led U.S investment grade corporate bonds to underperform the other major segments of the fixed income market. As a result of the underperformance of credit this year, we made the decision to increase the allocation to agency mortgage-backed securities across all fixed income accounts. This is a move that we believe will be beneficial to our clients' fixed income portfolios.


We believe that President Trump is closer to the beginning of his plan to tilt the United States' balance of trade in the favor of the U.S through the implementation of tariffs than he is to the end. We believe that the administration will continue to target the "usual targets"; i.e., Canada, Mexico, the EU, and especially China. However, we think that it is likely that President Trump could hit Japan with new tariffs in the coming months, a country that hasn’t been targeted much at all by the Trump Administration.

Despite the ongoing geopolitical risk surrounding the imposition of tariffs between the U.S. and foreign countries, we believe that many of the negative effects of tariffs have already been priced into international equities. As a result, our analysis suggests some pockets of value lie in both international developed and emerging market equities, which should cause the markets to perform in-line with if not outperform U.S. stocks throughout the third quarter.

The sectors we find the most appealing at the moment are financials and energy. Though we think much of the recent financial deregulation, the roll back of Dodd-Frank restrictions, has been priced into money center banks, there continues to be upside for smaller regional banks. In addition, the M&A environment in that segment of the industry remains high as smaller banks continue to consolidate. Though OPEC and Russia agreed to modestly boost production of crude in June in an effort to slightly curb the effects of higher prices, we believe that their continued support for tight production limits since mid-2017 coupled with a strong dollar will be supportive of prices going forward.

We expect the Federal Reserve to hike the Federal Funds rate twice more in 2018, at increments of 25 basis points. We don't view the chances of an additional third hike this year to be very high; however, we will consider the risk of such a move by the Fed. We believe that inflation will track at or slightly above 2% for the remainder of the year, which would throw the chances of a third rate hike out the window. Due to stable inflation at these levels, it is of our belief that the long bond, the 30 year Treasury Note, could end the year near it's year-to-date high of 3.25% of mid-May. The implication of such monetary policy and inflation would be a bear-flattening of the yield curve, in which mortgage-backed securities tend to benefit more from relative to U.S Treasuries and corporate debt.


Media Perspective

A recent article from the Wall Street Journal, (Halfway Through a Troubling Year) - In spite of troubled world markets, America's stocks are up!. (By James Mackintosh, Wall Street Journal)

Read More by James Mackintosh, Wall Street Journal article at the Halfway Through a Troubling Year.

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