2018 – 2nd Quarter Commentary

2018 – 2nd Quarter Commentary

To Our Valued Clients,

In review of the second quarter of 2018, clearly the ongoing trade conflict between President Trump and other nations was a main risk focus. Renewed trade tensions between the United States and China have sparked market volatility as the two nations announced roughly $50 billion in tariffs aimed at a broad basket of each other’s manufacturing bases. At the time of writing, the US-imposed tariffs are due to take effect on July 6th, while China vows to take immediate reciprocal action. The proposed US move was seemingly in response to claims of intellectual property theft by China and, in particular, worries about Chinese state-sponsored cyber operations targeting the US technology sector. China retaliated by targeting 106 valued American exports, including cars, planes and soybeans. Although trade disputes are normal in today’s global economy, the lack of bilateral resolution would eventually affect the equity prices of companies most exposed to tariffs, as these companies would inevitably face higher input costs or decreased consumer demand. Additionally, globalization has certainly linked supply chains, which makes it almost impossible to directly target one country without affecting others, creating spillover effects.

With many uncertainties swirling around these trade disputes, an important thing investors need to keep in mind is that the overall global economic and market environment remains quite strong. The attractive fundamental backdrop continues to be the primary driver of long-term returns. Most economies continue to expand, but challenges—some self-inflicted—are casting a shadow on what is an otherwise healthy climate for global business activity. Companies continue to experience positive earnings momentum that has improved throughout the first quarter of 2018, with the US equity market seeing the greatest amount of earnings strength. And, although we have seen increasing volatility thus far in 2018, one positive byproduct is that equity valuation multiples have begun to revert back towards historical averages. US equity forward price-to-earnings (P/E) ratios are about 15% off their recent peaks, while international equity multiples are about 12% lower. This results in global equity P/E ratios that are at their lowest since 2016, with many market participants suggesting a potential buying opportunity for long-term investors.

The current economic expansion is now officially the second-longest in the post WWII-era. Broad global economic growth continues, but momentum is slowing as we enter the later stages of the economic cycle. Historically, long-term investment trends often reverse later in the cycle. This makes rebalancing portfolios—trimming leaders and adding to laggards, and restoring the
portfolio’s long-term strategic asset allocation particularly important. With central banks retreating from the extraordinary policies put in place after the financial crisis, the Federal Reserve has increased the pace of rate hikes this year while slowly unwinding its balance sheet. Consequently, interest rate risk is one of the main challenges for the fixed income market, with longer-duration bonds declining in value to shorter-term bonds. The yield curve continues to flatten as the spread between short and long-term rates narrows, which gives way to the risk of an inverted yield curve. Inverted yield curves have preceded recessions in the past, although the time between an inversion and recession can be long and vary greatly—especially given the strong economic environment we are in. However, it is something that we continue to watch closely.

Although the ongoing trade dispute between the US and China certainly adds risk to equity markets, it is important to remember how the strong fundamental backdrop to the global economy remains intact and provides compelling opportunities across risk assets in 2018. Looking ahead to the third quarter, we remain generally optimistic but see heightened risks. Increased risks and geopolitical challenges will likely weigh on sentiment and contribute to volatility, creating opportunities for security selection and displaying the importance of diversification and prudent portfolio rebalancing.

As we head into the third quarter of 2018, we wish you and your families a happy and prosperous summer season. We thank you for your ongoing trust and confidence, and hope we can continue to help you discover The Next Piece – to Your Peace of Mind. ™ 

Best Regards,

Josh Williford, MSF

Director, Empowered Investor

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