Monica Knowles |

Neil D. Paolella, CPA July 2018

Stock prices were all over the map in a jittery second quarter as investors dumped holdings of large international companies on the fear that a trade war would stifle global growth, and increased their bets on shares of large technology companies. The major market indices finished the tumultuous three months mostly higher, even as investors were buffeted by worries about trade tensions and political uncertainty in the Eurozone, as well as signs of slowing momentum in the global economy (ex-US). The standout for the quarter was the tech-heavy Nasdaq Composite Index, which overcame an early slump to book its eighth straight gain. Investors are betting that the shares of technology companies will not be hurt by the trade sanction skirmish, and in fact may benefit from the increased pressure being placed on Chinese-sponsored intellectual property piracy. The Dow Jones Industrial Average eked out a meager gain in the second quarter, but the escalating trade tensions have punished the blue-chip index more than its peers and left it vulnerable to further volatility. Renewed threats from President Donald Trump to impose further tariffs and restrictions on China, which was followed by promises of retaliation from the Chinese, accentuated the global trade conflict and kept the Dow in negative territory for the year. Also weighing on the DJIA was the news that General Electric, its last original remaining member, was removed in favor of drug retailer Walgreens. The blue chip S&P 500 index, which has been attempting to mount a recovery since falling in February (off about 8% from its all-time high reached in January), rose 2.9% for the quarter, a nice move but trailed the Nasdaq’s impressive 6.3% advance. The two large stock indexes remain well below their January records, while the Nasdaq notched a series of all-time highs in June.

Also on the upswing for the quarter were small and midsized company stocks, which, after being ignored for what seems like forever, mounted a furious rally and ended the quarter in positive territory for the year. As measured by the Russell 2000 index, small and midsized company stocks are up 7% year to date. Credit for this positive performance can be attributed to the impression that smaller companies tend to do business domestically, and therefore are not materially affected by the trade donnybrook. Losers for the second quarter and for the year include international stocks and most fixed income investments, especially government bonds. International stocks are suffering from trade tensions, while bonds and fixed income investments are being pummeled by interest rate increases.

“Peace, commerce, and honest friendship with all nations- entangling alliances with none” Thomas Jefferson, 1801
I’ll Trade You a Steely for Two Cats Eyes and a Purie….

Worries about trade have roiled financial markets as the U.S. and China, the world’s two biggest economies, remain locked in a trade dispute. This should come as no surprise to anyone, as President Trump railed on unfair trade practices, especially targeting the Chinese, throughout his campaign and into his early presidency. The President made public his intention to levy trade tariffs on many imported commodities and products in an effort to re- negotiate what he deems as bad trade agreements with China, Europe and other trading partners. Has our President lost his marbles?

The U.S. economy’s strength, bolstered by tax reform and regulation relief, is emboldening the Trump administration to play hardball in its trade offensive against China. Tariffs tend to be economic downers with an impact like sales taxes, which push up costs for consumers and businesses and slow growth, but so far it is tough to argue that the spat with China is having a broad macroeconomic impact. Economic output in the second quarter is estimated by many economists to have expanded at a 4% annual rate or more, roughly twice the pace of the nine-year-old expansion. The jobless rate, meantime, is near lows last seen during the internet boom in 2000, and wages and incomes are rising modestly. That gives President Donald Trump’s administration what it sees as leeway to hit China without worrying as much about blowback from U.S. households or businesses caught in the crosshairs.

The Jefferson quote comes from his first inaugural address, a treatise on what he deemed “the essential principles of our government”. Elaborating on the matter of commerce, he wrote further- “Our interest is to throw open the doors of commerce and to knock off all its shackles, giving perfect freedom to all persons to the vent of whatever they may choose to bring into our ports, and asking the same in theirs”. President Jefferson knew that reciprocal free and open trade was necessary for a functioning democratic capitalist nation to succeed. Now, over 200 years later, President Trump is attempting to fulfill this Jeffersonian democratic economic prophesy by forcing our trading partners into re-negotiating trade agreements, putting goods and services made in the US and exported internationally on equal footing with those goods imported from our trading partners. This would go a long way to reversing our global trade imbalance (imports exceeding exports), which can be thought of as dollars and jobs leaving our country, never to return. At the present, markets are telling us that this trade melee is not likely to cause short-term disruptions to our economy. But should this skirmish accelerate into a long-term battle, all bets are off.

2018 Mid Year Market Outlook

Corporate earnings are poised to extend a run of double-digit growth for the second quarter, providing a balm for a stock market that has languished in a trading range around the break-even point. Analysts expect second quarter profit at S&P 500 companies to log a rise of 20% from a year earlier. Despite fears that earnings peaked in the first quarter, they remain on pace for the second-fastest growth rate in nearly eight years. Revenue also is expected to impress, with estimated growth of about 9% from the prior year- the fastest rate since 2011’s third quarter. The buoyant outlook for earnings highlights the vigor of U.S. business nine years into a domestic economic expansion. Gains from corporate tax cuts, a robust national economy and confidence among small businesses and consumers have given corporate earnings a fresh boost this year, helping offset headwinds such as the Trump administration’s contentious trade policies, and a rising interest rate program engineered by our Federal Reserve Bank.

History shows us that it takes a lot to kill a bull market, and this one is proving to be no exception. As explained in previous newsletters, they generally die at the birth of a recession, and recessions are frequently caused by the Fed getting too tight with money. At this time, earnings are so good; they are likely to overshadow the negatives, including the trade dispute. For now, it is still our expectation that 2018 will be a positive one for investors, with the bulk of the profits coming in the second half.

Portfolio Strategy

Given our expectations for positive equity market results this year, we are not materially changing our portfolio strategy at this time. However, the abrupt movement in interest rates has us planning to adjust the characteristics of our bond holdings to deal with the potential of permanent loss of principal

As always, if you have any questions regarding the above or your investment accounts, please contact us at your earliest convenience.


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