On the Horizon: 7 Focus Areas | Second Quarter 2018
In a Nutshell: While stock and bond market volatility receded a bit from the dramatic swings of the 1st quarter, it was not for lack of newsworthy events and actions. While we continued to hear about the Mueller investigation and the possibility of inflation, there was a marked uptick in significance and activity in global trade rhetoric and North Korean relations. Trade rhetoric became more worrisome though relations with North Korea appear to have improved. Markets will anxiously watch for follow through on both areas, as well as quite a few others.
For insights on each of these 7 focus areas, read below.
While unanticipated events always occur, there are typically some themes, data points and awaited events that can be reasonably expected to impact markets; it is those that we address below. In our comments we also attempt to gauge what the market may be anticipating given that markets typically place their bets ahead of actual announcements or resolutions based on what it believes the likely outcome is. Therefore, market reaction is often more a result of how different the result was from the prediction.
- Tariffs and Global Trade – last quarter we discussed the steel and aluminum tariff announcements that occurred in late February. Our concern then, as it is now, is less about these specific tariffs and more about the escalation of retaliatory actions and the threat of a full-scale trade war. The initial trade salvos from the U.S., China and others were modest in size and scope, but the most recent threats have served to escalate both markedly and financial markets have taken notice. International markets (weaker) and the US Dollar (stronger) have already seen a shift in sentiment. This is unlikely to be resolved quickly or without major repercussions/concessions and it is why we would view it as a significant current risk.
- Tax Reform Impacts – the economic impact from the 2017 year-end tax reforms has been recently overshadowed by the threats of a trade war. Markets initially reacted very favorably to the reforms and optimism abounded for strong economic and corporate earnings growth. Some of that excitement has worn off as it has become more evident that the pick-up in growth and earnings would not be immediate, but more gradual as the year progressed. Entering the 2nd half of the year, growth and earnings are expected to see some of this uptick. This uptick is likely already in analyst estimates, but with the focus on tariffs and global trade, there is still potential for strong headline numbers to buoy market sentiment.
- Synchronized Global Growth Story – Wall Street couldn’t have been more impressed by or talked more about the synchronized global growth story last year and early this year. As typically happens in such cases, expectations were elevated to lofty levels. Expectations were ratcheted up even more with the U.S. tax reforms and likely reached the point of being too optimistic and unreachable. Growth indeed did disappoint in some markets and as typically happens, an adjustment in estimates is necessary. It remains to be seen if the slower growth during the early part of the year is the result of normal cyclicality or something else. Given that expectations for growth were so uniformly high earlier in the year the rebasing of expectations should give investors some comfort that they are now more realistic.
- Inflation and the Fed – Low inflation levels have allowed the Fed and most global central banks to maintain their easy monetary policies for over a decade. The Fed has embarked on a path toward interest rate “normalization” and to this point has been able to do so at a slow, meticulous pace. One reason for the slower pace has been the lack of upward pressure on inflation despite a strong labor market. While recent movement in the inflation rate has been small, the trend has moved higher and market participants are paying close attention. Higher inflation would change two important market and interest rate assumptions. First, it would accelerate the pace of Fed rate hikes. Second, it would indicate that the point at which the Fed stops raising rates will be higher than previously thought. This is often referred to as their “neutral” rate. An additional wild card in the fight against inflation relates to the tariffs. Economists broadly expect that tariffs would result in an increase in inflation readings and likely lead to faster Fed action.
- Midterm Elections – While the election falls in the 4th quarter (November 6, 2018) political pollsters and the media will be busy prognosticating on the races that will decide whether the Democrats can gain control over Congress. Market nervousness is always a bit elevated around elections and this cycle promises to have more than its fair share of drama and mudslinging. If nothing else, the lead-up to the elections increases the rhetoric and reduces the focus on more important issues.
- Russia Investigation – The Mueller investigation continues to move forward and occasionally produces worrisome headlines for investors. It’s unclear exactly where the investigation is headed, but it continues to have the potential to meaningfully disrupt markets. Whether that potential is ever realized is anyone’s guess. The longer it drags on, the more investors become conditioned to look past the headlines and posturing, but the fact remains that the stakes are high and key members of the administration remain in the crosshairs. It is clearly a market moving event, but with no certainty of direction. An exoneration of the administration clears the air and removes the overhang. Anything less is likely to involve a long, drawn-out process creating additional uncertainty that markets dislike.
- North Korea – What a difference a quarter makes! North Korea has been a mainstay on these types of lists for years, but was usually something more on the periphery than a current news item. Anyone paying attention to the news the past few months knows that it was front and center with the historic meeting in June between President Trump and North Korean leader Kim Jong-un. The meeting resulted in several verbal agreements and commitments, but there was little in the way of specifics and only time will tell if there will be any meaningful follow through. Markets and the world will be closely watching, however, so it’ll remain a significant news item and have influence on investor sentiment. North Korean follow through on the denuclearization agreement would be a clear and significant win for the Trump Administration, whereas if they were to renege it would likely result in a return to more hostile saber rattling.
If it feels like the above list is full of more potential negatives than positives that is likely an outgrowth of the lengthy bull market we’ve enjoyed and our nature to be on the lookout for destabilizing news or events. There remain a number of positives that investors can point to that can support markets and potentially even drive them higher. Global growth has slowed relative to 2017, but it is still broadly strong. That is no more evident than in the U.S. where growth has markedly picked up during the 2nd quarter and is expected to continue through the course of the year. There is still much to be excited and positive about as an investor even if we need to temper our return expectations due to valuation levels. For more insight on the typical anticipated themes, data points and awaited events that can have an impact on the market, contact Brad Swinsburg 404-874-6244.
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Unless stated otherwise, any estimates or projections (including performance and risk) given in this presentation are intended to be forward-looking statements. Such estimates are subject to actual known and unknown risks, uncertainties, and other factors that could cause actual results to differ materially from those projected. The securities described within this presentation do not represent all of the securities purchased, sold or recommended for client accounts. The reader should not assume that an investment in such securities was or will be profitable. Past performance does not indicate future results.