The second quarter of 2018 brought about renewed growth in US stocks and volatile international markets. Small cap stocks (measured by the Russell 2000) led the way in the US with very strong gains of 7.75% after an uneventful first quarter. Over one year, global stocks have been solid with US markets showing strong gains and international (including emerging markets) showing modest but positive gains. Bonds (measured by the Barclay’s Aggregate Bond Index) are now modestly negative over 12 months but remain positive over three years.
This quarter feels a bit familiar relative to the last few years. US stocks leading the way, international stocks dragging a bit, but overall things are ticking up. It’s another time where we’ll find it is hard to be well diversified, including owning international stocks. Again I’ll remind you that markets are fickle and cyclical beasts. We will have times where we love US stocks, love international stocks, love Real Estate, hate bonds, hate emerging markets, you name it. There will always be something in the portfolio we’d wish we didn’t own, and it seems so easy to identify in hindsight. In real life, we can’t know where the market will move next, so we’ll stick to our obscenely boring well diversified portfolio and know that this process works in our favor over time.
Economic growth in the United States remains moderately positive across most indicators. Real Gross Domestic Product growth is still sitting in same muted range that it has been for most of the last decade, with the most recent reading from Q1 coming in at 2.0%.
Perhaps most significantly, the Federal Reserve raised rates during the second quarter for the second time this year. The target rate is now 1.75% – 2.00%, continuing a steady rate of increases over the past few quarters. Additionally, the Fed chair indicated it is likely that we will see two more rate increases in 2018, a change from three total to four total rate increases as expected earlier this year.
The reason the Fed is accelerating the rate of increases is that inflation has now been solidly at or above the Board’s target rate of 2.0% for some time and the Board is now primarily concerned with keeping inflation and the rate of economic growth in check, where just a few years ago the primary concern was low employment and stagnant wage growth. Unemployment is now just 3.8%, historically one of the lowest levels on record.
While unremarkable, the most economic indicators point to ongoing positive growth. Industrial production was modestly lower in May 2018, but solidly higher at 3.5% year-over-year growth and 2% above the pre-recession peak in 2007. Capacity utilization remains muted at 77.9%, below the long-run average of 79.8.
The job market is still very strong for labor and job seekers. Job openings continue to grow, unemployment by any measure is trending downward and more and more workers are voluntarily leaving their existing jobs, a large sign of confidence among the labor force.
Housing markets in the US are mixed. National home prices are still moving upwards, while at a more modest rate than we had seen in years past. Pending home sales, however, slipped in May by 0.5%, the fifth consecutive month of declines. Rising interest rates will affect buyers’ ability to finance and this is often one of the first segments of the economy to be affected by higher interest rates. New home construction, measured by housing starts, shows that builders are confident and supply is on the way up. Starts were up 5.0% month-to-month in May, and up 20.3% compared to May 2017. These figures are coming off of what was a very low base of new construction coming out of the 2008-2009 recession and single family starts are still very far below levels seen from 1992-2007.
Tax & Legislative Updates
Since the federal spending bill was passed in late March, there has been very little legislative activity from Washington, and certainly little that affects economic or tax policy. The most significant political activity that affects markets has been the imposition of trade tariffs across many industries, most notably steel and aluminum imports. These tariffs, as high as 25% for steel imports and 10% on aluminum, have sparked retaliatory actions and threats of action from trade partners include the European Union, Canada, Mexico and China.
There is near universal agreement that tariffs and subsequent retaliations will harm the global economy and the average US citizen via higher prices on trade goods. It is still early to see what, if any, economic impact these actions may bring but it is doubtful that on balance they will be beneficial to global economic output.
It has been an easy and generally quiet quarter to be an investor. Once again we should remember to appreciate these quiet moments in the markets, when it seems oh-so-easy to see portfolio values grow steadily. We should note the absence of fear and panic, realize that this isn’t always the case. We aren’t nervous about a global health scare or threat of war, a pending financial crisis or catastrophe. This won’t always be the case, and eventually we’ll be faced with free-falling markets and account values that aren’t what the used to be. These quiet times are part of investing, and those panicked times are too! They are an inevitable part of our future. Don’t forget!