2nd Quarter Market Review
John Fischer, CFA®, CFP® | Chief Investment Officer
July 16, 2018
Should Investors Express Gratitude for Volatility?
Has there ever been a moment in your life where you felt sure you hit rock bottom? Looking back at that period in your life, consider how you felt in the moment: you probably felt like there was no bouncing back, but look at where you are now.
Maybe it was when you got laid off, but dealing with that challenge led to your dream job or your own business. Or it might have been when you experienced a catastrophic failure that became a tipping point on your path to success.
Blessings in disguise are difficult to appreciate because they hardly feel like blessings at all in the moment. It takes time and the perspective of hindsight to see the big picture in life — and often times, in your investment portfolio, too.
2018 marks the 10th year of the market’s economic expansion, but investors experienced an unusually rocky stretch for the first half of the year. In the past 2 years, the S&P 500 index closed up or down 1% a total of 54 times — and two-thirds of those days happened in the past 6 months.
A sharp uptick in volatility can test the will of investors to remain invested for the long-term. Market fluctuations often result in stocks declining, which can feel painful and alarming in the moment. But the fact that the S&P 500 still managed a positive return for the first half of 2018 despite the significant market volatility could be viewed as one of those blessings in disguise.
What’s $50 Billion in Tariffs Amongst Friends?
Escalating trade tensions between China and the U.S. served as a main driver of market volatility in the second quarter. While the billions in tariffs threatened by each country seem significant at face value, it’s important to view these numbers within context.
Total trade (imports and exports) for the U.S. in 2017 was $3.9 trillion while U.S. GDP was $19 trillion.1 As a percentage of total trade and the U.S. economy, these tariffs are quite small.
Still, those “small” tariffs could apply pressure to the economy as the price of goods goes up. That, in turn, could hurt consumer confidence. Additionally, tariffs will affect the supply chain of businesses, which could raise production costs and dampen companies’ views on further hiring and business investment.
We remain confident that the trade disputes will be resolved before we reach the point of a full-blown trade war. At the same time, real negotiations have yet to take place as the tariffs have gone from threat to reality. Investors shouldn’t expect this market risk to go away overnight. We’ll likely see ongoing spurts of market volatility as long as tariffs are headline news.
Despite Tariff Tiffs, the Market Remains Resilient
The market stayed afloat in the first half of the year despite concerns that ranged from geopolitical issues (with North Korea) and trade policy worries (with tariff disputes with China and other ally countries) to monetary concerns, with the Fed raising interest rates. The strength of the economy and corporate earnings allowed the market to tread water in spite of these perils.
The well-being of U.S. consumers did even more to support overall market performance, given the fact that these consumers make up two-thirds of U.S. GDP. Unemployment hit 3.8% in May, a level not seen since 2000. This low unemployment rate, along with improved wage growth, left consumers feeling increasingly confident and happy to spend (which supports the economy).
Meanwhile, the S&P 500 reported first-quarter earnings growth that exceeded 20% growth for the first time since 2010. Corporate tax cuts and the overall strength of the consumer and the economy played key roles here. While we’ll likely see the benefits of tax cuts to corporate earnings begin to fade in 2019, they should provide a nice tailwind for the rest of the year.
Bonds, What Are They Good For?
In June, the Fed announced another hike to the Fed funds rate. This continued climb caused some investors to question the value of owning bonds as part of their diversified portfolio.
It’s critical investors remember that the Fed funds rate is an overnight lending rate. While it directly impacts the direction of short-term rates, it has very little effect on intermediate and long-term bonds.
Since December 2015, the Fed has raised the Fed funds rate by 1.75%. During that time, 10-year Treasury yields increased by only 0.60% while 30-year Treasury yields didn’t rise at all.
Bonds are a valuable part of a diversified portfolio because when stocks are down, bonds are often up, thus cementing their role as an “airbag” for portfolios when stocks struggle. Thus, bonds help investors remain invested during the tough times when stocks have fallen.
In the final 2 weeks of the second quarter, the S&P 500 index was down 2% as investors worried about the impact of the looming tariffs. During that time, the U.S. Aggregate Bond Index was up, cushioning the impact of falling stocks and demonstrating the value of bonds as part of a diversified portfolio.
2018’s Volatile Market Offers a Blessing in Disguise
The current economic expansion is now the second longest in U.S. history. At the end of market cycles, we’ve historically seen investors display euphoric tendencies and adjust their portfolios to take more risk than they should. Then when markets turn volatile, investors lose more than they can tolerate, and sell at the worst possible time.
The recent market fluctuation is a timely reminder to investors that stocks are volatile and risky. For those investors who heed this lesson from the first half of 2018 and make sure their portfolio is not assuming more risk than they can tolerate, they will have learned the lesson without the pain of a market downturn.
The hardest part about blessings in disguise is that they’re difficult to see in the moment. We encourage investors to take advantage of the recent market volatility and review their portfolios to make sure the amount of risk represented there is aligned with their financial goals, tolerance for risk, and time horizon.
The alternative is learning the lesson the hard way when the next market downturn strikes.
Source: 1 Foreign Trade, U.S. Census, https://www.census.gov/foreign-trade/statistics/highlights/annual.html, 7/13/18
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