Review
In the 3rd quarter of 2018, the S&P 500 had its best quarter since 2013. The index returned more than 7% for the quarter. The quarter saw a continuation of strong consumer retail sales and manufacturing data. Those positive data points, along with a robust employment environment and record corporate earnings, signify a healthy US economy. Inflation remained calm even with such strong momentum in the US economy. However, the US Federal Reserve raised rates for the 3rd time in 2018 bringing the federal funds rate from 2.00% to 2.25%.
Outlook
As fantastic as the 3rd quarter was, the same cannot be said so far for the 4th quarter. We are through a very disappointing first month which saw the S&P 500 retreat almost 7%. The decline was the worst month since September 2011. There are a few factors that led to the decline and areas to watch as we close out the year.
A potential peak in corporate earnings combined with a hawkish Federal Reserve were the major contributing factors to the decline and anxiety moving forward. Although the majority of corporate earnings reports came in better than expected, a significant number of the reporting companies revised forward guidance downward. A significant amount of companies that revised future earnings downward cited ongoing tariff banter between the US and China as a reason. Also on the minds of investors is whether or not the US Federal Reserve will hike rates for a fourth time in 2018. Concerns that corporate earnings have peaked, combined with a Fed possibly tightening too fast brings fear we may slip into a recession sooner than expected.
We will keep our eye on mid-term elections to see if there are any changes in power within the house or senate. If either become majority controlled by the Democratic party, we could see a halt to any significant policies being passed. We will also be keeping an eye on forward leading recession indicators. For the most part, leading indicators are not currently showing signs of impending recession, however a slow down in some housing sectors (i.e. New York) and a flattening of the yield curve have our attention. Finally, the fed and US/China trade wars could push the market drastically one way or another. If the Fed continues to tighten and tariffs continue, it could accelerate the likelihood of a recession. However, if trade issues are resolved, it could potentially spring board the markets into double digit gains.
Equities
Even though October was volatile and negative, keep in mind that markets typically see three 5% pullbacks and one 10% pullbacks annually. We have been spoiled into forgetting that volatility exists, is common and is healthy. Volatility in equities outside of recessionary conditions create buying, not selling opportunities for equities. A perfect example was the 5% gain the market had in the final 2 days of the month.
We are still positive on US equities but will use, if necessary, upward movements in this asset class to reduce equity exposure if events such as corporate earning reports, trade wars or economic data points lead us to believe markets may begin to wane over the mid to long term. International markets do not look as strong as the US, but are beginning to look extremely cheap from a valuation standpoint. However, we are cautious since any US slowdown would further deteriorate the international sector as well.
Fixed Income
We maintain our stance on the potential for increasing interest rates in the US. With the flattening of the yield curve, we could seek shorter duration fixed income categories to reduce both interest rate and return risk.
Alternatives
With economies around the world growing and our primary concern being inflation, we believe that the addition of commodities to our portfolios will provide opportunities for return and a hedge against inflation.
As always, I stress that in this ever-changing political and economic environment, sensible diversification is the key to weathering any market uncertainties.
Jason M. Vavra, CPA, PFS
Email: jvavra@vcm-wealth.com
Website: www.vcm-wealth.com
Twitter: @VavCap
Disclaimer
The information contained herein is not considered an offer to buy or sell any securities referred to herein. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. There is no guarantee that the figures or opinions forecasted in this report will be realized or achieved. Past performance is no guarantee of future results.
