Fall 2018 Quarterly Commentary

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The Fall can be a tumultuous time for the markets. Volatility can increase as hedge funds and mutual fund managers reposition their portfolios by selling losers and chasing winners. This year we expect amplified volatility after last year’s very strong returns, this year’s solid returns and a midterm election on the horizon.

We believe it will be important to remember in the coming months how and why the market got to these higher levels in the first place! Fiscal stimulus (corporate tax cuts) has replaced monetary stimulus (Fed keeping interest rates low) at just the right time. Deregulation has spurred business confidence, hiring and investment. As a result, economic growth and corporate earnings are accelerating. Yes, interest rates are rising but we argue for all the right reasons! However, risks are prevalent so patience is warranted. Stay tuned!

Economic Positives

Cha-Ching! Business investment is on a tear – up 12.9% year-over-year. Multi-decade highs in the age of existing equipment, immediate expensing of capex due to recent tax law changes and accelerating business optimism have all contributed to recent gains. This has the potential to lengthen the business cycle.

More Jobs = Strong Consumer Confidence: Recent employment gains have resulted in millions of people dropping off food stamps which has put jobless claims near 50-year lows. As a result, average hourly earnings are on the rise (up 2.8%) and recent confidence data is near 17-year highs.

U.S. Manufacturing Is Reaccelerating! The September reading for U.S. manufacturing just advanced to four-month highs and reached its third-highest level over the past twelve months. Manufacturing is important in the U.S. as it has some of the highest-paying jobs and is a good barometer for biz investment.

Economic Negatives

Rising Rates May Put A Lid On Housing: JP Morgan Chase is planning layoffs in its mortgage division weeks after rival Wells Fargo announced similar cuts. Management in those banking divisions have seen weakness due to higher interest rates. Is this as good as it gets in housing?

The U.S. Debt Problem Is Not Going Away! While corporate and consumer balance sheets remain healthy and strong in relation to year’s past, overall debt levels are higher than before the 2007-09 Financial Crisis! Rising rates have led to higher debt service costs which may take away from future economic growth.

Will The Fiscal ‘Sugar High’ Fade? We are closely watching the current U.S. – China trade negotiations. A long and protracted negotiation may negatively impact our economy by mid-2019 as some benefits of the corporate tax cuts fade and we experience higher import costs. Could this cause a recession?

Market Negatives

How High Can Interest Rates Go? Long-term interest rates (10-years to 30-years) have broken through highs last seen in February and are currently approaching levels of nearly 10 years ago. The good news is that it is due to stronger economic growth. However, the bad news is that it has pressured stocks in the near-term.

The Political Climate Has Become Nasty! If Justice Kavanaugh’s nomination proceedings are any indication, we are in for more hostility and volatility as we approach midterm elections in early-November. However, we have looked back in time and the market has typically performed quite well afterwards!

China, China, China!!! While the market was encouraged by the recent USMCA trade deal, the 800-lb gorilla in the room remains our ongoing trade negotiations with China. Unfortunately, the negative rhetoric has ramped up which may push a deal further out. We believe compromise is a matter of when, not if!

Market Positives

NAFTA 2.0! President Trump’s recent trade deal (called the USMCA) with Canada and Mexico has eliminated a significant market overhang and improved sentiment. It also gives us hope that this administration can formalize a deal with China in the near to intermediate-term.

Strong Foreign Investment Flows Continue! The United States’ stronger economy and higher interest rates have attracted significant investment capital from abroad. This has resulted in significant outperformance of U.S. assets relative to the rest of the world. We expect this trend to continue.

The U.S. Great Rotation Has Not Yet Started! Surprisingly, the current U.S. bull market has been unloved by retail investors as much more money has gone into bonds vs. stocks. As interest rates rise, we expect a multi-year rotation to stocks flowing from bonds. This should favor high-quality, dividend-paying equities.