Second Quarter 2018
A Strong Economy
With all that has been happening during the 2nd quarter, it is amazing that the U.S. economy is tracking along very nicely. The same cannot be said for the rest of the world. Even as the world economy has been doing well, the markets remain very volatile.
As we saw in the first quarter, businesses continued to invest large amounts into capital projects and capital improvements. When businesses invest in their infrastructure, this is a positive sign. Capital improvements help allow for growth of a business and often result in greater productivity gains. Individuals are being brought along with the growth.
Corporations are showing strong profits but are often falling short of investor expectations. Unemployment is at record lows. Employees are being trained like we haven’t seen in years. Incomes are rising. The strength of the employment market has given workers a sense of wellbeing in knowing that they are needed and can, once again, change jobs if they choose. Another by-product is consumer spending. For example, retail sales in May were up 1.3% over April, and June was up 0.5% over May. Economists at Barclays have pushed their estimate of second-quarter gross-domestic-product growth up to 5.2% from 5%.
Let’s look at the numbers for the second quarter of 2018. The quarter began with the S&P 500 at 2641. It ended the quarter at 2718, with a gain of 77 points or 3%. For the year the S&P 500 has gone from 2674 to 2718 or 44 points for a gain of 1.7% for the year to date. The mid-cap stocks, represented by the S&P MidCap 400, began the quarter at 1879, ending the quarter at 1951 for a gain of 72 points or 3.8%. For the year, this index has gone from 1901 to 1951, a gain of 50 points or 2.6% year to date. Small stocks, represented by the S&P SmallCap 600, began the quarter at 938 and ended at 1017 for a gain of 79 points or 8.4%. For the year, they have gone from 967 to 1017, an increase of 50 points and a gain of 5.2% year to date. International markets, represented by the DJ Global ex US index, began the quarter at 262 and ended the quarter at 254 for a loss of 8 points or -3%. Since the beginning of the year, this index is down from 267 to 254, a loss of 13 points or -4.9%.
Interest on the 10-year Treasury Note rose during the quarter from 2.741 to 2.847 for a negative return of -0.04%. For the year to date, the note has gone from 2.49 to 2.847 for a loss of 36 points or -0.14%. The Bloomberg Barclays US Aggregate Bond Index went from a yield of 3.13% at the beginning of the quarter to 3.3% at the end, giving a negative return of -0.54%. At the beginning of the year, the index stood at 2.97 and is now down -1.1% year to date.
Where Are We Going?
This is the big question. The U.S. and world economies are used to changes, even disruptive changes. We are currently seeing massive disruptive changes. Trade tariffs are embroiling the world in a “tit for tat” exchange that is helping no one. Whirlpool, the maker of such consumer appliances as washers and dryers, was ecstatic when the government put trade tariffs on similar appliances coming from South Korea, notably LG and Samsung. This elation was short lived, when the government placed import duties on steel. Suddenly the manufacturing cost for Whirlpool increased, and their second quarter profit was down 66%.
This is called cause and effect. In our aggressive stance with Canada, our longest ally in trade, we have imposed massive tariffs on paper and aluminum imports. This has had a very bad impact on newspapers, where the cost of low-grade paper, used for newsprint, has increased dramatically. Newspapers were already having profit problems as readership is down, and this added burden may further exacerbate their ability to earn a profit. Alcoa continues to import aluminum from Canada, at much higher prices, to meet aluminum demand in the U.S.
So, who is paying for all the tariffs being imposed by the government? Ultimately, it is you, the consumer. A 25% import tax on foreign cars will likely raise the price of a car by about $5,000, according to Subaru, which will make their cars uncompetitive and allow U.S. carmakers to raise their prices. So much for competition.
For corporations that must manage their businesses in this environment, the tariffs pose a serious problem in planning for the future. Investors can’t decipher which industries are being helped and which are being hurt. When we add this uncertainty to a mid-term election year (which have created volatility in markets going back to the 1890’s) we have more uncertainty than markets can accommodate.
Enter the Fed
Every game needs a wild card. While they might not be “wild”, the impact of rate hikes by the Federal Reserve slows down the economy. So far this year, the Fed has raised its benchmark rate twice, moving it from 1.25% at the beginning of the year to 1.75% currently. It appears that they may raise it twice more this year, possibly bringing the rate to 2.25%. When the rate rises, borrowing costs for businesses increase, the value of bonds drops, mortgage rates escalate, consumer credit costs go up and therefore consumer prices rise. When we add the Fed’s action to the tariffs, we get what could be a combustible formula for the economy. But, we don’t know what will happen and we don’t know what to do.
When we add all of the above together, we get lots of uncertainty. The markets do not like uncertainty. Uncertainty leads to volatility. Volatility puts investors on edge. Like it or not, you must decide what to do going forward. Because you can’t decipher who the winners or losers will be, you need to be broadly diversified. The economy is doing well, and it is in no one’s best interest to see it stumble. We have been through worse uncertainty in the past, and it seems reasonable that we will get though this as well. For now, it seems the best game plan is to remain well diversified.
Posted July 24, 2018